UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK
----------------------------------------------------- x
In re:
Chapter 11
ENRON CORP., et al.,
Case No. 01-16034 (AJG)
Debtors.
Jointly Administered
----------------------------------------------------- x
REPORT OF NEAL BATSON, COURT-APPOINTED EXAMINER, IN
CONNECTION WITH THE EXAMINATION OF NATIONAL ENERGY
PRODUCTION CORPORATION PURSUANT TO COURT ORDER
DATED DECEMBER 6, 2002
April 7, 2003
TABLE OF CONTENTS
I.
EXECUTIVE SUMMARY
1
A.
Overview
1
B.
Issues Addressed in this Report
3
C.
Summary of Conclusions .....•........................................................................... 5
II.
NEPCO AND ITS ROLE IN ENRON'S CASH MANAGEMENT SYSTEM
A.
NEPCO Entities and the NEPCO Business
B.
Enron's Cash Management System
C.
NEPCO's Participation in the CMS
D.
Circumstances Surrounding NEPCO's Participation in the CMS
E.
TracingNEPCO's Cash
~
14
14
18
23
26
31
III. NEPCO'S POST-PETITION ACTIONS
A.
Impact ofEnron's Bankruptcy Filing
B.
SNC-Lavalin Transaction
37
37
40
IV. CONCLUSIONS AND RECOMMENDATIONS
A.
Conclusions
B.
Recommendations
42
42
43
Exhibit 1
Exhibit 2
Exhibit 3
Enron Cash Management System Accounts
NEPCO Cash Receipts by Month, 2001
NEPCO Cash Receipts by Customer, 2001
AppendixA-
Applicable Legal Standards
I.
EXECUTIVE SUMMARY
A.
Overview
On May 20, 2002, National Energy Production Corporation (''NEPCO''), an
indirect wholly owned subsidiary of Enron Corp. ("Enron"), and certain of its
subsidiaries and related companies (collectively, the ''NEPCO Debtors")! filed voluntary
petitions for relief under Chapter 11 of Title 11 of the United States Code (the
"Bankruptcy Code") with the United States Bankruptcy Court for the Southern District of
New York (the "Court"). The NEPCO Debtors sought joint administration of their cases
with the Chapter 11 case previously filed by Enron on December 2, 2001 (the "Enron
Petition Date").
In connection with the filing of the NEPCO Debtors' bankruptcy petitions, the
NEPCO Debtors submitted an affidavit of their ChiefExecutive Officer, G. Brian Stanley
(the "Stanley Affidavit"). The Stanley Affidavit stated that the NEPCO Debtors had been
rendered insolvent, in part, because $360 million had been "swept,,2 from the NEPCO
Debtors' bank account into Enroncontrolled bank accounts pursuant to Enron's cash
management system (the "CMS").3 Following the NEPCO Debtors' bankruptcy filings,
certain customers of the NEPCO Debtors and creditors of such customers (collectively,
the "Claimants") filed various pleadings with the Court asserting, among other things,
that the NEPCO Debtors had been injured by the cash sweep into the CMS and that the
1 The NEPCO Debtors are: (i) NEPCO, (ii) two ofNEPCO's wholly owned subsidiaries, NEPCO Power
Procurement Company (''NPPC'') and NEPCO Services International, Inc. ("NSII") and (iii) Enron Power
& Industrial Construction Company ("EPIC"), an indirect wholly owned subsidiary of NEPCO's direct
parent, Enron Engineering & Construction Company ("EE&CC").
The terms "sweep" and "swept" can be used in various ways. In this Report, the Examiner will use the
terms "sweep" and "swept" to refer to the process by which cash was transferred into and throughout
Enron'scash management system.
2
3
Stanley Affidavit ~ 20.
NEPCO Debtors, or the Claimants as subrogees of the NEPCO Debtors, should be
permitted to assert a constructive trust4 over the swept cash. Furthermore, certain of the
Claimants requested that the Court appoint a trustee or an examiner to investigate the
issues related thereto.
By Order dated October 7, 2002 (the "October i
h
Order"), the Court ordered the
appointment of an examiner to address the issues raised by the Claimants.
The
October 7th Order also provided that Neal Batson (the "Examiner"), who previously had
been appointed by the Court to investigate, among other things, the use by Enron of
special purpose vehicles,S would serve as the examiner to investigate certain of the issues
raised by the Claimants. The Examiner, at the direction of the Court, submitted his
recommendation regarding the structure and scope of his investigation. 6 By Order dated
December 6, 2002 (the "December 6th Order"), the Court approved the Examiner's
4 Under applicable law, to assert a constructive trust the putative beneficiary must show: (i) fraud or a
breach of a fiduciary duty or confidential relationship; (ii) unjust enrichment of the putative trustee, and
(iii) specific identification of the property as to which a trust should be imposed. A more detailed
discussion of constructive trusts is included in Appendix A (Applicable Legal Standards) attached hereto.
By Order dated April 8, 2002 (the "April 8th Order"), the Court had authorized and directed the
appointment of an examiner, pursuant to 11 U.S.C. § 1104(c), to investigate, inter alia, the use by Emon of
special purpose vehicles (or entities created or structured by Emon or at the behest ofEmon) (the "SPEs")
in connection with its finances. On Mal 22, 2002, the United States Trustee appointed Neal Batson as the
Examiner contemplated by the April 8 Order. The Court, by Order dated May 24, 2002, approved the
United States Trustee's appointment of Neal Batson as Examiner. To date, the Examiner has submitted
two interim reports pursuant to the April 8th Order.
5
On November 11,2002, the Examiner submitted the Recommendation of Neal Batson, Court-Appointed
Examiner, with Respect to Scope and Time Frame of the Examination Pursuant to Court Order Dated
October 7, 2002 (the "Initial Recommendation"), Docket No. 7747; and on December 4, 2002, the
Examiner submitted the Supplemental Recommendation of Neal Batson, Court-Appointed Examiner, with
Respect to Scope and Time Frame of the Examination Pursuant to the Court's Order Dated October 7,2002
(the "Supplemental Recommendation"), Docket No. 8192.
)
6
-2-
recommendation regarding the scope of his investigation and directed the Examiner to
investigate Enron's acquisition and use ofNEPCO's cash through the CMS.?
B.
Issues Addressed in this Report
This report (the "Report,,)8 addresses the following issues specifically
recommended by the Examiner and adopted in the December 6th Order:
1.
the amounts and timing of sweeps of cash generated by NEPCO
(''NEPCO Cash") into the CMS;
2.
the sources of the NEPCO Cash swept into the CMS;
3.
the disposition of the swept cash by Enron, including the location
of deposits and the details of its use, if any;
4.
whether the swept NEPCQ Cash can be traced;
5.
whether any fraud, dishonesty, incompetence, misconduct,
mismanagement or irregularity by NEPCO or Enron occurred in
connection with the cash sweeps; and
6.
whether the factual and legal predicates for the imposition of a
constructive trust for the amount of the cash swept by Enron may
be asserted by NEPCO.
This Report does not address: (i) the ability of a particular Claimant to assert
claims against theNEPCO Debtors or Enron; (ii) the ability of the Claimants to assert a
7 Order Approving the Supplemental Recommendation of Neal Batson, the Court-Appointed Examiner,
with Respect to Scope and Time Frame of the Examination Pursuant to the Court's Order Dated October 7,
2002, Docket No. 8235.
8 Any references in this Report to meetings, communications, contacts, and actions between the Examiner
and third parties are intended to refer to the office of the Examiner, which shall include the Examiner and
his professionals. Therefore, references to any meetings, communications, contacts and actions taking
place between the Examiner and a third party should not be construed as indicating that Neal Batson was
present personally for such meetings, communications, contacts or actions.
"
-3-
statutory trust against NEPCO or through NEPCO against Enron;9 or (iii) issues
concerning the post-petition sale of certain assets of the NEPCO Debtors or other postpetition conduct ofthe NEPCO Debtors, Enron or third-parties. Io
Although technically possible to confme the analysis in this Report to the NEPCO
Debtors, the Examiner believes that such analysis would by its very nature be an
incomplete analysis ofNEPCO's business .and the sources and uses of the NEPCO Cash.
Therefore, this Report will sometimes refer to the term "NEPCO Entities" which
collectively refers to the NEPCO Debtors and three related entities. These related entities
are: (i) Thai NEPCO Co., Ltd. ("Thai NEPCO"), a wholly owned subsidiary of
NEPCO; II (ii) Pakistan Construction Services, Inc. ("Pakistan NEPCO"), a wholly
owned subsidiary of EE&CC; 12 and (iii) NEPCO Procurement Company ("NPC"), a
division of Enron Equipment Procurement Company, .an indirect wholly owned
subsidiary of Enron. 13 The seven entities comprising theNEPCO Entities were the
In this regard, the Examiner has not undertaken to discuss the possible claims by contractors (or any
subrogee of the contractors) under applicable state law with respect to the imposition of a statutory trust
against either NEPCO or Enron. The law of certain states may authorize, in limited circumstances, the
holders of mechanics' liens or similar claims to assert statutory trust claims; however, the Examiner has
concluded that this potential theory of recovery is creditor specific and does not affect the analysis of the
relationship between NEPCOas putative constructive trust beneficiary and Enron as putative constructive
trust trustee.
9
10 The Examiner's recommendation proposed, among other things, that the examination be conducted in
stages. The first stage would analyze NEPCO's ability to assert a constructive trust over the funds it
deposited into the CMS. Later stages, to be undertaken only after further direction from the Court, would
analyze the rights of specific Claimants to assert a constructive or other trust against NEPCO or Enron, and
other issues raised by Claimants related to the post-petition actions of NEPCO and Enron, including the
$NC Transaction (as dermed below).
11 Thai NEPCO was formed to construct two power generation facilities in Thailand. It was dOrmarIt in
2001.
12 Pakistan NEPCO was established to construct a power generation facility in Pakistan. It was effectively
dormant in 2001.
13 NPC was established after Enron purchased NEPCO. It procured many ofthe large equipment items for
NEPCO projects. In 2001, NPC did not have any cash receipts, but approximately $250 million was
disbursed from the CMS on its behalf, all related to projects undertaken by NEPCO.
)
-4-
entities through which NEPCO's business was operated. I4
These related entities
undertook all of their operations on behalf of NEPCO by perfonning services and
providing goods to NEPCO that enabled NEPCO to satisfy its contractual obligations to
its customers. Thus, all cash transactions conducted between NEPCO and such related
companies were treated by Enron and NEPCO's management as NEPCO related
transactions and were reflected in the inter-company balances on both Enron's and
NEPCO's financial accounts and records. I5 NEPCO is the only NEPCO Entity that
contributed any cash into the CMS during 2001. The Examiner has concluded that
NEPCO is the only NEPCO Entity that could attempt to impose a constructive trust
against Enron.
Accordingly, this Report discusses NEPCO's ability to impose a
constructive trust rather than the ability of other NEPCO Entities to impose such a trust.
C.
Summary of Conclusions
As set forth more fully below, the Examiner has reached the following
conclusions:
(i)
The amounts and timing ofsweeps ofNEPCO Cash into the CMS
NEPCO's cash collections were swept into the CMS each day by the transfer of
its collections from an account at Bank of America into an Enron controlled step account,
and then into a single concentration account used by Enron to accumulate the daily cash
14 Telephone Interview with George Brian Stanley, former Chief Executive Officer, NEPCO, by David M.
Maxwell and Atiqua Hashem, Alston & Bird LLP, March 10,2003 (the "Stanley Interview"); In-Person
Interview with John Gillis, former President, NEPCO, and Steve Daniels, former Vice President, Busirless
Development, NEPCO, by David M. Maxwell and Atiqua Hashem, Alston & Bird LLP, Feb. 19,2003 (the
"Gillis/Daniels Interview").
15 NEPCO
Combirled Trial Balance [AB0507 00760-AB0507 00761].
November
-5-
2001
[AB0507 00757-AB0507 0075~]
and
receipts of Enron and its subsidiaries. I6 The funds in the Bank of America concentration
account were wire transferred daily to a disbursement concentration account at Citibank:,
N.A. ("Citibank") used by Enron to pay its obligations and the obligations of its
subsidiaries, including the NEPCO Entities.
The total amount of NEPCO Cash transferred into the CMS for the period from
January 1, 2001 17 through November 30, 2001 was $1.720 billion. Is For the same period,
the CMS supplied $1.401 billion to pay the NEPCO Entities' operating expenses and
other obligations. The difference, $319 million, represents the net cash contribution by
NEPCO to the CMS during 2001. 19
This net increase in NEPCO's contribution to the CMS is reflected in the
combined inter-company receivable balance in NEPCO's 2001 financial statements. The
net receivable grew from $83 million at the end of 2000 to $388 million at the end of
November 2001. 20 The increase of $305 million equals the net contribution of cash by
NEPCO ($319 million), less $14 million of inter-company assessments. NEPCO's net
16 NEPCO's initial collections account, the step account into which it was swept, and the corporate
collections concentration account into which the step account was swept were all accounts maintained at
Bank of America, N.A ("Bank of America").
17 The Examiner has focused his analysis in this Report on 2001, the year prior to the Enron Petition Date,
because, among other reasons, approximately eighty percent (80%) of the inter-company balance between
NEPCO and Enron was generated in 2001. Furthermore, analysis of prior years would not affect the
ultimate conclusions in this Report.
18 Analysis of Examiner's Accounting Professionals (the "Accounting Professionals' Analysis")
[AB050701345].
19 NEPCO could theoretically assert that it should be able to trace the entire $1.720 billion that NEPCO
contributed to the CMS during this period and ignore the $1.401 billion of funds that the NEPCO Entities
received during this period. That is, there should not be any "netting" of the amounts placed into the CMS
by NEPCO against the benefit received by the NEPCO Entities. The Examiner is unaware of any
published decisions that address this issue. However, the Examiner has concluded that this position is
untenable in the context of a constructive trust because it ignores the critical unjust enrichment component
that is at the essence of this equitable remedy.
NEPCO Combined Trial Balance - Year End 2000 [AB0507 00763-AB0507 00764] and
[AB0507 00766-AB0507 00767]; NEPCO Combined Trial Balance - November 2001 [AB050700757AB0507 00758] and [AB0507 00760-AB0507 00761].
)
20
-6-
cash contribution in 2001, and the resulting increase in its receivable balance from Enron,
is detailed below:
Cash Transactions
NEPCO Cash into CMS
$1.720 billion
Payments by CMS on NEPCO Entities' behalf $1.401 billion
$ 319 million
Net Cash Contribution
Inter-Company NEPCO Receivable Impact
Beginning Net Receivable Balance
Ending Net Receivable Balance
$ 83 million
$388 million
Net increase in Receivable Balance
$30S-million
Inter-Company Assessments21
$ 14 million
Total Cash Impact to Receivable Balance
$319 million
Although there was an increase in the inter-company receivable from January 1, 2001 to
the Enron Petition Date, for the period from September 12, 2001 through the Enron
Petition Date, the NEPCO Entities actually were net consumers of cash from the CMS in
an amount exceeding $57 million. That is, they received approximately $57 million of
cash from the CMS in excess of NEPCO Cash contributed to the CMS during such
time. 22
(ii)
The sources ofthe NEPCO Cash swept into the CMS
The $1.720 billion of NEPCO Cash swept into the CMS in 2001 was received
from two sources: (i) $1.547 billion from domestic customer payments to NEPCO under
lump sum engineering, procurement and construction contracts ("EPC contracts")
2\
These consist of non-cash transactions for assessed taxes, overhead and other indirect expenses.
22 $455 million ofNEPCO Cash was swept into the CMS but $512 million came from the eMS to satisfy
obligations of the NEPCO Entities. Accounting Professionals' Analysis [AB0507 01356]. The Examiner
has analyzed in detail the period between September 12, 2001 and the Enron Petition Date because on
September 12, 2001 the entire CMS was in a cash negative position by more than $200 million. See
discussion below regarding how NEPCO's ability to impose a constructive trust may be extinguished by
this negative cash position.
-'
-7-
between NEPCO and its customers,23 and (ii) $173 million from receipts related to an
international power plant project in Brazi1?4 Of the $1.720 billion of receipts in 2001,
the Examiner has tracked $1.702 billion, or 99%, to seventeen specific domestic
construction projects and the above-referenced Brazilian power plant. 25 Each of these
receipts was collected in response to invoices generated by NEPCO when specific,
identifiable and agreed upon milestones in its EPC contracts were achieved.
(iii)
The disposition of the swept .cash by Enron, including the
location ofdeposits and the details o/its use, if any
NEPCO Cash was used in the same manner as cash received from all of the other
Enron subsidiaries that participated in the CMS. It was swept into the CMS through
various layers of consolidation accounts at Bank of America, all controlled by Enron,
and then wire transferred to a single Enron owned and controlled disbursement
concentration account at Citibank. From the Citibank concentration account, the funds
were used to pay the current obligations of Enron and its subsidiaries. The CMS funds
were used, in part, to pay the expenses and obligations of the NEPCO Entities as those
obligations became due. 26 In 2001, approximately $1.4 billion of funds were paid by the
CMS on behalf of the NEPCO Entities. Each NEPCO account in the CMS is identified
in the diagram in Section II.C. ofthis Report.
In-Person Interview with Robert Cranmer, former Chief Financial Officer, NEPCO, by David M.
Maxwell and Atiqua Hashem, Alston & Bird LLP, Feb. 20, 2003 (the "Cranmer Interview"); Stanley
Interview.
23
24 The $173 million was deposited into the accounts ofNEPCO's direct parent, EE&CC, but was treated as
funds ofNEPCO and credited to NEPCO's combined inter-company receivable balance.
The remaining I% consists of numerous small deposits. While these deposits were not traced to a
specific project, there is no indication that the deposits came from sources other than those identified
above.
25
Each disbursement from the Citibank concentration account, and each of the step and specific
disbursement accounts below it, may be tracked by payee, but to do so would necessitate an audit of each
such account. Such an audit would be expensive and the analysis would not affect the Examiner's
conclusions in this Report. Therefore, the Examiner did not undertake suchan audit.
-'
26
-8-
(iv)
Whether the swept NEPCO Cash can be traced
The NEPCO Cash swept into the CMS can be traced, usmg the lowest
intennediate balance rule,27 into several different accounts in the CMS. However, there
are three notable facts that the Examiner believes will effectively prohibit or limit
significantly NEPCO's ability to satisfy the tracing element in order to establish a
constructive trust. They are:
•
On September 12, 2001, the CMS was, on an aggregate basis, in a cash
negative position of approximately $238 million (the "September 1ih
Negative Balance").
•
Between September 12, 2001 and the Enron Petition Date, the NEPCO
Entities were net consumers of cash from the CMS of approximately $57
million (the ''Net Consumer Status,,).28
•
On November 30,2001, the CMS, on an aggregate basis, was reduced to
approximately $56.3 million, of which only approximately $23 million
was potentially NEPCO Cash (the "November 30th Minimal Balance").
The September 12th Negative Balance eliminates any res as of that date. After
that date, the Net Consumer Status eliminates any basis to claim unjust enrichment. The
November 30th Minimal Balance indicates that even if any res did survive after
September 12, 2001 and even if there had been unjust enrichment, the value of such res
would not exceed approximately $23 million.
The lowest intermediate balance rule is used to trace trust funds that are commingled with non-trust
funds ina bank account. The rule assumes that trust funds are the last funds to be removed from a
commingled account, there1;>y making the trust identifiable as long as the balance in the account remains
above the value of the trust. A more detailed discussion of constructive trusts and this tracing rule is
included in Appendix A (Applicable Legal Standards) attached hereto.
27
The $57 million was calculated by aggregating the payments made by the CMS during this period to
satisfy the obligations of all of the NEPCO Entities. As discussed above, all NEPCO Cash was paid
directly by NEPCO's customers into NEPCO's cash collections account, discussed below, which was part
of the CMS. During this period, cash was disbursed by the CMS on behalf of all of the NEPCO Entities.
All of these cash disbursements on behalf of the NEPCO Entities were related to NEPCO's business
operations and were made on account of obligations for which NEPCO was primarily obligated under an
EPC contract. As a result, the Examiner believes that aggregating these payments is appropriate in
analyzing the ability of NEPCO to impose a constructive trust because this approach accords with the
critical unjust enrichment component that is the essence of the equitable remedy of a constructive trUst.
28
-9-
The Examiner notes that there are several judgments to be made in connection
with analyzing the foregoing facts for which there are no published decisions directly on
point and, as a result, there may be a contrary view.29 However, as discussed more fully
below, despite the lack of direct authority, the Examiner has analyzed these issues under
general equitable principles of tracing to reach his conclusions.
In addition, there may be another avenue available to NEPCO to trace funds - if
NEPCO was permitted to trace funds to Enron related accounts external to the CMS?O If
permitted to do this, there may be additional funds available over which NEPCO could
attempt to assert a constructive trust. Attempting to trace the cash through the eMS and
into other non-CMS accounts, or other Enron assets, would be time consuming,
uncertain3l and extremely expensive. Given the difficulties surrounding NEPCO's ability
to establish the other elements of a constructive trust as discussed in this Report, the
Examiner does not recommend undertaking such an audit.
They are: (i) whether there can be a netting of amounts contributed into the CMS by NEPCOagainst
amounts received by the NEPCO Entities out of the CMS and (ii) whether it is appropriate to use the
aggregate amount of cash in the CMS to determine, at a point in time, if the res has been extinguished
(e.g., where the concentration disbursement account has a negative cash position that is so large that on an
aggregate basis the CMS is in a negative cash position even though there are positive amounts of cash in
the other applicable CMS accounts).
29
In Appendix A (Applicable Legal Standards), the Examiner discusses the reported cases addressing the
application of the lowest intermediate balance rule to trace funds where there are multiple accounts. No
case is directly on point. However, in Majutama v. Drexel Burnham Lambert Group, Inc. (In re Drexel
Burnham Lambert, Inc.), 142 B.R. 623 (S.D.N.Y. 1992), the bankruptcy court, in addition to allowing the
plaintiff to conduct discovery concerning the principal account into which the funds allegedly subject to a
constructive trust were deposited, also allowed the plaintiff to conduct discovery concerning other accounts
of the defendant. The bankruptcy court refused to permit discovery of transfers into accounts of
independent subsidiary corporations of the defendant/debtor. However, on appeal, the district court
affIrmed the grant of summary judgment in favor of the debtor, holding that once the plaintiffs' funds
disappeared from the initial account, the tracing had to stop. If this Court were to permit NEPCO to
attempt to trace funds into accounts outside the CMS, the attempt would require an audit of each Enron
account worldwide to determine fIrst if commingled CMS funds came into the account, and if so, whether
the lowest intermediate balance rule would enable NEPCO to assert a trust over any or all remaining funds
in the subject account. The Examiner's accountants estimate that such an audit would take approximately
six to eight months and cost between $2 and $5 million.
30
31
See Section II.E. below for a discussion of the uncertainties and complexities associated with such an
)
un&m~g.
-10-
(v)
Whether anyfraud, dishonesty, incompetence, misconduct,
mismanagement or irregularity by NEPCO or Enron occurred in
connection with the cash sweeps
The Examiner has found no evidence of fraud, negligence or other malfeasance
with regard to NEPCO's participation in the CMS or in connection with the sweep of
NEPCO Cash into the CMS.NEPCO appears to have participated in Enron's CMS in the
same manner and to the same extent as substantially all other wholly owned domestic
Enron affiliates. In addition, there does not appear to have been any change in the CMS,
or NEPCO's participation in the CMS, in the months prior to the Enron Petition Date.
Furthermore, there is no indication that (i) either NEPCO or Enron accelerated cash
collections or delayed cash payments on behalf of NEPCO (or otherNEPCO Entities),
prior to the Enron Petition Date32 or (ii) Enron forced or pressured NEPCO to enter into
EPC contracts as a financing tool for Enron.
(vi)
Whether the factual and legal predicates for the imposition
of a constructive trust for the amount of the NEPCO Cash
swept by Enron may be asserted by NEPCO
The requisite elements for the imposition of a constructive trust by NEPCO over
the funds swept to Enron via the CMS do not appear to be present. 33 Specifically, in
order to prevail in asserting a constructive trust against Enron, NEPCO must demonstrate
each of the following:
(i) fraud or a breach of a fiduciary duty or confidential
relationship; (ii) Enron was unjustly enriched, and (iii) NEPCO can trace its funds into
identifiable accounts in the possession of Enron. 34
As noted above, the NEPCO Entities enjoyed a Net Consumer Status for the period from September 12,
2001 through the Emon Petition Date in excess of$57 million.
32
As discussed in Appendix A (Applicable Legal Standards), bankruptcy courts generally look to relevant
state law to determine the elements necessary to establish a constructive trust.
33
34
See Appendix A (Applicable Legal Standards).
-11-
None of these elements appear to be present. As noted above, the Examiner has
found no evidence of fraud, negligence or other malfeasance by either NEPCO or Enron
with respect to the CMS.
In addition, it is unlikely that NEPCO will be able to
demonstrate that Enron owed it a fiduciary duty merely because Enron was its ultimate
parent, or that there is any other basis for finding a fiduciary relationship or one of special
confidence or trust. Nor is it likely thatNEPCO will be able to demonstrate that a
fiduciary or similar duty owed to it by Enron, to the extent one existed, was breached as a
result of the operation of the CMS. Enron's CMS was
e~tablished
before it acquired
NEPCO, the CMS had a legitimate corporate purpose, and it does not appear that NEPCO
was treated differently under the CMS than any other domestic wholly owned affiliate of
Enron that participated in the CMS.
It also is unlikely that Enron was unjustly enriched by the CMS. During 2001, the
NEPCO Entities did contribute more to the CMS than they had taken out: they made a
net cash contribution of $319 million to the eMS as of the Enron Petition Date.
However, the mere fact of a positive cash balance, without more, does not appear to meet
the "unjust enrichment" standard required under the law for the imposition of a
constructive trust.
Moreover, NEPCO would be required to identify specific property, in this
instance bank account funds, over which it could assert a constructive trust. As discussed
above, the September 12th Negative Balance would extinguish any res as ofthat date, and
the Net Consumer Status of the NEPCO Entities after September 12, 2001 would
eliminate any claim of unjust enrichment. Furthermore, assuming arguendo NEPCO is
able to establish a res after September 12, 2001, and assuming arguendo some unjust
-12-
enrichment occurred after that date, the November 30th Minimal Balance limits NEPCO's
potential res to a maximum amount of $23 million.
-13-
II.
NEPCO AND ITS ROLE IN ENRON'S CASH MANAGEMENT SYSTEM
A.
NEPCO Entities and the NEPCO Business
NEPCO was in the business of constructing large power generation facilities in
the United States and, to a lesser extent, overseas. 35 NEPCO engineered and built, on a
turnkey basis, electric power plants for its customers, and had been in this business for
many years. 36
Enron purchased NEPCO in 1997 from Zum Industries, Inc. ("Zurn,,).37 Once
affiliated with Enron,38 NEPCO was able to pursue and obtain substantially more and
larger projects. This primarily was a result of Enron's ability to guarantee NEPCO's
perfonnance on its projects. 39 Accordingly, from 199840 to 2001, the aggregate revenues
35
Stanley Interview; GillislDaniels Interview.
NEPCO first began operation in 1938 as Bumstead-Woolford. Paul Nyhan, Enron Subsidiary Nepco
Cuts 40 from Bothell Work Force, Seattle Post-Intelligencer Reporter, April 25, 2002, at Dl, available at
http://seattlepi.nwsource.comlbusiness/67864 nepc025.shtml.
36
37 Letter from Zum Industries, Inc. to Enron Corp. dated Oct. 20, 1997 (accepting post-closing adjustment
in purchase price pursuant to Purchase and Sale Agreement dated July 31, 1997) [AB0276 00441~
AB0276 00442].
Initially, NEPCO was a wholly owned subsidiary of EE&CC, which in turn was a wholly owned
subsidiary of Enron. During 2001, as Enron restructured its operations, different Enron entities were given
operational responsibility for NEPCO. In March 2001, Enron announced the formation of a new
corporation, Enron Engineering and Operational Services Company ("EEOS"), which included NEPCO,
EE&CC and a third entity, Operational Energy Corporation. In September 2001, Enron announced the
formation of Enron Global Services ("EGS") and EEOS (along with NEPCO) thereafter reported to EGS.
Stanley Interview.
38
Despite these organizational changes, the individuals responsible for NEPCO's day-to-day operations
rernainedconstant. John Gillis, who had been President of NEPCO since Enron acquired the company
from Zum in 1997, continued as President. Mr. Gillis reported to the Chief Operating Officer ofEE&CC,
who for most of2001 was Keith Dodson. Mr. Dodson in turn reported to G. Brian Stanley, who was Chief
Executive Officer ofEE&CC and thenEEOS until early 2002.
Enron's guarantees enabled NEPCO to obtain more and larger projects than it previously had been able
to obtain. The guarantees gave customers, who otherwise would have required external bonding for the
project, the security they required. Deposition of Timothy J. Detmering, Managing Director of Corporate
Development, Enron Corp. by Mark N. Parry, Moses & Singer LLP, Aug. 23, 2002, at 60, lines 19-25, In
re Enron Corp., et al., C.A. No. 01-16034 (AJG) (Bankr. S.D.N.Y.) (the "Detmering Depo., at _ , lines
39
-").
40
1998 is the first full year NEPCO was affiliated with Enron.
-14-
of NEPCO (and the other NEPCO Entities) increased from $202 million to more than
$2.2 billion.41
NEPCO entered into EPC contracts with the owners of the plants to be
constructed by NEPCO. The EPC contracts provided for payments by the owners based
upon a negotiated and agreed series of milestones set forth in detail in the contract. 42
When a milestone was achieved (e.g., when the foundation of a building was completed),
NEPCO submitted an invoice to its customer. Generally, the customer employed an
independent engineer to review the progress of construction and make an independent
assessment of whether the specific milestone had in fact been achieved. Additionally,
when a project was financed by a lender, the lender's own independent engineer would
often monitor the construction process and review invoices. Once an invoice received the
necessary approvals, the customer paid NEPCO. 43
NEPCO and the other NEPCO Entities paid vendors and subcontractors as
supplies were delivered or work was performed on the various projects. These payments
were made on behalf of the NEPCO Entities out of the CMS. Ensuring that sufficient
funds are available to pay the vendors and subcontractors is a major part of a contractor's
business risk. Accordingly, contractors generally attempt to frontload their contracts to
ensure that they have received sufficient funds from their customer to cover the costs
41 NEPCO Combined Trial Balance - Year End 1998 IAB0507 00748]; NEPCO Combined Trial Balance
- November 2001 [AB0507 00756] and [AB0507 00759].
See Section 7.4, Turnkey Engineering, Procurement and Construction Agreement by and between
Ouachita Power, LLC as Owner, and National Energy Production Corporation as Contractor dated as of
June 27, 2003 (the "Ouachita EPC Contract") [AB0294 00297-AB0294 00423].
42
See Section 6.03(a), Amended and Restated Turnkey Engineering, Procurement and Construction
Agreement for Combined-Cycle Generation Facility between Panda Gila River, L.P. and National Energy
Production Corporation dated as of April 30, 2001 but effective as of Feb. 28, 2001 [AB0283 00484AB0283 00599].
)
43
-15-
owed to suppliers and vendors as those invoices come due. 44 Absent this frontloading, a
contractor could find itself "loaning" money to its customers by paying suppliers before it
had been paid. 45
NEPCO thus attempted to frontload its contracts to ensure that
sufficient cash had come in from its customers to keep it in a cash positive position as the
vendors and subcontractors were paid.46
The milestone payments, then, did not
necessarily represent a reimbursement for or prepayment of actual expenditures by
NEPCO at any given time.
Instead, these payments were the product of advance
negotiations regarding how much the customer would pay for completion of the specific
milestone.
NEPCO established, on occasion, wholly owned subsidiaries through which it
conducted business.
Specifically, NPPC was established as the purchasing ann of
NEPCO in an effort to minimize certain sales and use tax expenses, and NSII was
established to staff international projects for NEPCO. 47 Also, NEPCO's direct parent
corporation, EE&CC, established EPIC to provide union labor in connection with one
NEPCO project in Oregon. 48 In addition, Thai NEPCO was formed to construct two
44 In-Person Interview with David Hattery, In-House Counsel at Enron Corp. assigned to work on NEPCO
matters, by David M. Maxwell and Atiqua Hashem, Alston & Bird LLP, Feb. 19,2003 (the "Hattery
Interview"). See John D. Hastie, "Architectural and Construction Contracts - The Developer's
Perspective," R18l ALI-ABA 1731, 1731 (June 28, 1993).
This was especially problematic for a contractor in NEPCO's line of business where the vendor's
invoice could be in the tens of millions of dollars. See Ouachita EPC Contract at Exhibit E - Project
Milestone Payment Schedule (frrst progress payment on a gas turbine shown as $54,731,980).
45
46
Hattery Interview.
In-Person Interview with Keith Marlow, former Chief Financial Officer, EE&CC, by David M. Maxwell
and Atiqua Hashem, Alston & Bird LLP, Feb. 18,2003 (the "Marlow Interview"); Corporate Data Sheet:
NSII [AB0647 00020-AB0647 00022].
47
48
Marlow Interview.
-16-
power generation facilities in Thailand. 49 It was dormant in 2001. 50 Pakistan NEPCO
was established to construct a power generation facility in Pakistan. It was effectively
dormant in 2001; no cash was received by or disbursed on behalf of Pakistan
Construction Services, Inc. in 2001, there was, however, one tax assessment adjustment
of approximately $500,000 in 2001. 51 Finally, NPC was a division of Enron Equipment
Procurement Company, an indirect wholly owned subsidiary of Enron.
NPC was
established after NEPCO was purchased by Enron in 1997.52 It procured many of the
large equipment items for NEPCO projects. As NEPCOgrew, NEPCO established its
own purchasing company, NPPC.
After this date, NPC and NPPC appear to have
continued to be used for procurement by NEPCO. 53 In 2001, approximately $250 million
of purchases by NPC were paid out of funds from the CMS. 54 All of these purchases ~
i.e., all of these CMS funds ~ were related to NEPCO projects. 55 Moreover, although
NPC was not owned by the same direct parent as the NEPCO Debtors,NEPCO and
Enron management treated NPC as part of NEPCO for management and financial
reporting purposes. 56
49
Corporate Data Sheet: Thai NEPCO [AB0647 00017-AB0647 00019].
Marlow Interview; NEPCO Combined Trial Balance - November 2001 [AB050700756] and
[AB050700759].
50
51
NEPCO Combined Trial Balance - November 2001 [AB0507 00756] and [AB0507 00759].
52
Stanley Interview.
53
Stanley Interview.
54
Accounting Professionals' Analysis [AB0507 01347].
55
!d.
56
Stanley Interview; NEPCO Combined Trial Balance - November 2001 [AB050700756] and
[AB050700759].
)
-17-
B.
Enron's Cash Management System
Enron, like many large United States corporations, utilized a centralized system of
cash management in order to maximize its investment yield on its cash position and
minimize its cost of borrowing. 57 Additionally, the centralization of cash management
permitted increased control over the cash thereby minimizing the risk of malfeasance or
negligence with respect to such cash. Enron required that substantially all of its wholly
owned domestic subsidiaries participate in the CMS.58 The CMS was in place before
Enron acquired NEPCO.59
In-Person Interview with Mary Perkins, Vice President, Financial Support and Assistant Treasurer,
Enron Corp., by Dennis J. Connolly and David M. Maxwell, Alston & Bird LLP, Jan. 29, 2003 (the
"Perkins January 29 Interview"); Telephone Interview with Mary Perkins, Vice President, Financial
Support and Assistant Treasurer, Enron Corp., by David M. Maxwell and Atiqua Hashem, Alston & Bird
LLP, March 12, 2003 (the "Perkins March 12 Interview").
57
Perkins January 29 Interview; Perkins March 12 Interview. See also "Enron Minimum Cash Control
Standards," Oct. 2000 (showing "policy will apply to all entities and joint ventures where Enron Corp.
directly or indirectly owns greater than 50% of the voting rights of the entity") (the "Enron Treasury
Policy") [AB0295 0003G-AB0295 00043].
58
59
Perkins January 29 Interview.
-18-
The structure of Enron's CMS is outlined in the following diagram:
ENRON CMS PROCESS
COMMERCIAL
PAPER
J.P. MORGAN
OVERNIGHT
INVESTMENT
CITffiANK
BANK OF AMERICA
PAYROLL
COLLECTIONS
CONCENTRATION
ACCOUNT
DISBURSEMENTS
CONCENTRATION
ACCOUNT
OTHER
USES
STEP
DISBURSEMENT
ACCOUNT
BUSINESS
SPECIFIC
COLLECTIONS
ACCOUNT
BUSINESS
SPECIFIC
COLLECTIONS
ACCOUNT
BUSINESS
SPECIFIC
COLLECTIONS
ACCOUNT
STEP
DISBURSEMENT
ACCOUNT
BUSINESS
SPECIFIC
ACCOUNT
BUSINESS
SPECIFIC
ACCOUNT
BUSINESS
SPECIFIC
COLLECTIONS
ACCOUNT
The CMS structure consisted of numerous accounts at two banks: Bank of America and
Citibank, with Bank of America providing the collection accounts and Citibank providing
the disbursement accounts.
Under the Enron Treasury Policy, Enron affiliates were
instructed to open a collections account at Bank of America and to direct their customers
to make payments to that account. 60 At the close of each business day, the funds in the
60
Enron Treasury Policy; Perkins January 29 Interview; Perkins March 12 Interview.
-19-
collections accounts were transferred by a zero balancing transaction61 into a specific
"step" account, also at Bank of America. In general, the step accounts were established
for each of Enron's business units or groups of businesses in similar industries. 62 From
the step accounts the cash funds were zero balanced into a single concentration account at
Bank of America for Enron and substantially all of its subsidiaries.
The funds in the Bank of America concentration account were wire transferred
each day to a single disbursement concentration account at Citibank. Funds from other
sources, including proceeds from Enron's daily borrowings, also were deposited into this
disbursement concentration account at Citibank. 63
The funds in the disbursement
concentration account were used in a wide variety of ways.
obligations were paid directly from this account.
Enron'scorporate
The obligations of participating
affiliates (including the NEPCO Entities) were paid from lower level disbursement step
accounts. These disbursement step accounts were "daylight overdraft" zero balancing
Zero balancing can consist of either removing funds from an account to bring its balance to zero or, if
applicable, depositing funds into an account to bring its balance to zero. As a practical matter, unless an
unusual circumstance occurred (e.g., a misdirected wire transfer) both the NEPCO collections account and
the step account were always positive at the end of a day and thus, in order to be zero balanced, those funds
would be moved into the concentration account.
61
62
Perkins January 29 Interview.
Prior to October 24, 2001, Enron's working capital borrowings consisted primarily of sales of
commercial paper. After that date it no longer had the ability to sell commercial paper in the market and
consequently made drawings under its $3 billion of revolving lines of credit. These lines of credit
consisted of a 364-day revolving credit agreement in an amount up to $1.750 billion and a longer term
revolving credit agreement in an amount up to $1.250 billion. These lines were made available by a
syndicate of fInancial institutions with Citibank serving as Administrative Agent (collectively, the
"Revolving Credit Lines") [AB0507 00467-AB 0507 00474]. Perkins January 29 Interview.
63
-20-
accounts64 that at the close of each day were zero balanced with the Citibank
concentration account.
The CMS was driven each day by decisions made by Enron's Treasury
Department. Each morning the Treasury Department would analyze the expected cash
receipts and the expected cash needs for that day in order to "set" Enron's cash position.
Once this position was set - i.e., once it was determined how much cash Enron would
need on a given day and how much borrowing or repaying of debt would be necessary to
achieve that position65
-
the Treasury Department began to move cash to and from
various accounts as needed. Generally, Enron was a "net borrower" and it was required
to borrow each day to fund its operations. 66
The Treasury Department monitored the cash position throughout the day. If it
became apparent that the cash position as set earlier in the day was in error, the Treasury
Department either would obtain more funds or utilize the excess funds. 67 If additional
funding was needed, and time permitted, Enron would sell additional commercial paper.
If time did not permit additional commercial paper to be sold, Enron had access to its two
64 A daylight overdraft account is an account from which the bank permits disbursements even though
funds are not in the account, as long as the funds are deposited into the account at the close of the day.
Accordingly, Emon's daylight overdraft step disbursement accounts were used each day to pay obligations
as they came due; at the close of each business day each account zero balanced with the Citibank
concentration account by taking from that account sufficient funds to cover that day's disbursements.
65 The position was "set" by approximately 10:00 each morning at which time a borrowing or payment
decision was made by the Treasury Department. Once a decision to borrow or repay funds was made by
the Treasury Department, it was not reversible that day. Perkins January 29 Interview.
In-Person Interview with Mary Perkins, Vice President Financial Support and Assistant Treasurer,Emon
Corp. by David M. Maxwell, Alston & Bird LLP, Jan. 9, 2003 (the "Perkins January 9 Interview"); Perkins
March 12 Interview.
66
67
Perkins January 9 Interview.
-21-
Revolving Credit Lines, totaling $3 billion. 68 If, on the other hand, Enron had more cash
at the end of the day than it had estimated, it either would repay its commercial paper
debt iftime permitted or invest the funds. 69
Thus, at the end of a given day if the Treasury Department had estimated the
receipts and uses of cash accurately, Enron would have a zero balance in its cash
management system ~ it would effectively have used all of that day's receipts, borrowed
only as much as was necessary to meet its obligations and ended with a balance at or near
zero. As a practical matter, this was an impossibility. Estimating the anticipated receipts
on a given day was especially difficult.
It was generally easier to estimate the
disbursements because Enron had control over whether or not it would disburse its cash;
however, Enron had no control over whether its customers would payor whether they
would pay timely.
Once the Treasury Department had made its receipts estimate, it would wire
transfer funds from the Bank of America concentration account to the Citibank
concentration account. 70
Of course, on occasion, errors occurred and the Treasury
Department moved more money from the Bank of America concentration account than
actually carne into that account on a given day. When this occurred, the Bank of America
concentration account was overdrawn and Bank of America would, in effect, make a
Enron did not draw upon its Revolving Credit Lines until October 25, 2001 when it borrowed the entire
amount of each line. The full amount of the Revolving Credit Lines remained outstanding as of the Enron
Petition Date. Perkins January 9 Interview; Perkins January 29 Interview.
68
69 Enron preferred to repay outstanding borrowings rather than invest because it believed that repayment
generated a higher return. Perkins January 9 Interview; Perkins January 29 Interview.
As noted above., this generally occurred at approximately midmorning each day. If the amount to be
wire transferred was sufficiently large, Enron would divide it into several smaller transfers. Perkins
March 12 Interview.
70
-22-
"loan" to Enron equal to the amount of overdrawn funds. 71 More often, however, there
was a remaining balance in the Bank of America collections account at the end of a given
day.
This amount was transferred by Bank of America into an overnight off-shore
investment account in Nassau, the Bahamas. The principal and overnight interest earned
was redeposited into the Bank of America concentration account the next morning.
A similar process took place at Citibank. At the conclusion of .each day, any
funds remaining in the concentration account were transferred and invested by Citibank
in an off-shore overnight investment account. The following morning the principal along
with the interest earned was redeposited into the Citibank concentration account. 72
The specific bank accounts linked to the CMS changed as Enron's business
changed; accounts were added and deleted as needed. The identity of the accounts
connected to the eMS as ofNovember 30, 2001 is set forth in the attached Exhibit 1.
C.
NEPCO's Participation in the CMS
Enron required NEPCO to participate in the CMSY Under the Enron Treasury
Policy, for all practical purposes, substantially all of Enron's domestic wholly owned
subsidiaries were required to participate in the CMS. 74 In addition, NEPCO did not have
the accounting personnel, equipment or wherewithal to operate independent of a
71 Enron attempted to avoid this situation because the interest expense on the overdrawn funds was Enron's
highest cost of borrowing. Perkins January 9 Interview; Perkins January 29 Interview.
72
Perkins January 9 Interview.
73
Marlow Interview; Enron Treasury Policy, at 2.
74
Perkins January 9 Interview; Enron Treasury Policy, at 2.
-23-
centralized cash management systemY Indeed, prior to Enron's acquisition of NEPCO
from Zum, NEPCO had participated in Zum's centralized cash management system. 76
NEPCO'scash was deposited into the CMS via a series of zero balancing
accounts, described above, that automatically removed cash from the NEPCO collections
account and consolidated that cash into larger accounts within the CMS. 77
75 See "Financial Analysis and Reporting Project" draft of Arthur Andersen, dated Sept. 2001, at 2 (noting
that a full time Chief Financial Officer and staff of project accountants did not exist at NEPCO)
[AB0279 01423-AB0279 01427]; GillislDaniels Interview.
76
GillislDaniels Interview.
77
Perkins January 9 Interview.
-24-
The structure of the NEPCO Entities account participation within the CMS is
shown in the diagram below.
NEPCO CMS ACCOUNT STRUCTURE
Bank of America
Citibank
Enron Corp
Overnight
Investment
Account
t
EnronCorp
Overnight
Investment
Account
JP Morgan Chase
(Clearing Agt)
Commercial Paper
Settlement Account
t
#144000763
I
EnronCorp
Receipt
Concentration
Account
#3750494015
....
~
Enron Corp
Disbursement
Concentration
Account
#3751311977
(owned by Enron
Corp.)
Various other
EE&CC
Accounts
#3751311948
Outside Investments
(Merrill Lynch,
Goldman Sachs,
etc.)
t
EE&CC
disbursement
account for wire
transfers
EnronCorp
Citibank Delaware
Payroll
Transactions
#40807423
#3910-9855
t
i i
NEPCO
Collections
Account
....
....
#00076486
i
EE&CCCash
Services Account
~
EE&CC
disbursement
account for
check writing
#3861181
NEPCO's receipts were deposited into NEPCO's collections account, Account
No. 3751311948, at Bank of America?8
Each day the collections account was
consolidated by a zero balancing transaction into step Account No. 3751311977 at Bank
78
Perkins March 12 Interview.
-25-
of America. 79 This step account was itself zero balanced and consolidated, along with
other step accounts, into the corporate-wide cash concentration account at Bank: of
America, Account No. 3750494015.
Once the NEPCO funds were in the Bank: of
America concentration account they were transferred, along with other commingled
funds, to Enron's disbursement concentration account, Account No. 00076486, at
Citibank:.
From the Citibank: concentration account, the commingled funds were used by the
Enron Treasury Department as described in the previous section. That is, the applicable
NEPCO Entity's obligations were paid out of the CMS from one of two EE&CC step
disbursement accounts at Citibank:: Account No. 40807423 was used for wire transfers
and Account No. 386118180 was used for check payments. In sum, NEPCO's cash was
taken into the CMS, and the applicable NEPCO Entity's obligations were paid out of the
CMS, in the same way as substantially all other domestic wholly owned Enron affiliates.
D.
Circumstances Surrounding NEPCO's Participation in the CMS
Participation Consistent with Prior Practice
NEPCO's participation in the CMS in the months preceding the Enron Petition
Date was consistent with its previous participation in the eMS. NEPCO continued to
invoice its customers for milestone payments, collect those payments in its Bank: of
America collections account, allow those funds to be swept into the CMS each day as
part of the zero balancing activities, and obtain from the CMS payment of its current
obligations and obligations of the applicable NEPCO Entity.
79
Bank of America account number 3751311977 was a step accountfor all EE&CC transactions.
The EE&CC check writing account, Account No. 3861181, was not linked directly to the Citibank
concentration account. Rather, it was linked to the EE&CC wire transfer account, Account No. 40807423,
which in tum was linked to the concentration account.
80
-26-
No Attempt to Improperly Accelerate Collections or Delay Payments
It is clear that both Enron's management and NEPCO's management were aware
in 2001 of Enron's favorable cash position with respect to NEPCO. Indeed, in the
summer of 2001, this issue was an impediment to Enron's attempt to sell NEPCO. 81
However, the Examiner has found no evidence to indicate that collections were
accelerated by either NEPCO or Enron. The Examiner's review indicates that any such
acceleration would have been difficult, if not impossible. NEPCO had a finite number of
customers to which it could issue invoices. In addition, for each NEPCO project there
existed an EPC contract with specifically identified milestone payments negotiated in
advance. Thus, an invoice was issued to a customer only when a specific milestone on a
given project was achieved.
81 In the summer of 2001, shortly after Mr. Stanley assumed responsibility for EE&CC (and with it
NEPCO), Emon's senior management determined that NEPCO was not a core business and that it should
be sold. Stanley Interview. Timothy Detmering, then a senior manager of Emon North America Corp.,
was asked to manage the process of selling NEPCO. In the late spring and summer of 2001, Mr.
Detmering assembled a team and began an analysis of how to position NEPCO for sale. As part of Mr.
Detmering's efforts, he retained Arthur Andersen ("Andersen") and Lehman Brothers ("Lehman").
Detmering Depo., at 42, lines 1-4 and at 73, lines 1-9. Andersen was directed to undertake a complete
audit ofNEPCO's books for 1998 thorough 2000 (at that time the last full year of activity). Lehman was
requested to assist in identifying potential purchasers. ld. at 71, lines 23~25. It quickly became apparent to
Mr. Detmering and his team that a saleofNEPCO was going to be difficult. First, Andersen's preliminary
audit revealed that NEPCO's books and records were not in good order and, more significantly, that the
2000 profits generated by the NEPCO business would have to be restated downward because NEPCO had
underestimated remaining completion costs and thus overstated earned income. In addition, Emon realized
that due to timing considerations most ofNEPCO's projects were substantially cash positive (i.e., they had
received more cash at that time than had been paid to vendors and subcontractors) and that in order to sell
NEPCO, Emon would have to effectively put substantial amounts of cash back into NEPCO either as an
adjustment to the sales price or an actual contribution of cash at the sale. "Presentation to Stan Horton,"
Oct. 9, 2001 by R.A. Lydecker, at 5 (stating "Track record complicates any transaction ~ Emon would have
to put back $104 - $163 million in cash") [AB0277 01278-AB0277 01300]. Finally, Emon realized that
the guarantees it had provided to NEPCO's customers were so substantial that few, if any, purchasers could
afford to assume them. Detmering Depo., at 74, lines 14-19. It was unacceptable to Emon to sell NEPCO
without the purchaser's assumption of these guarantees because that would be too risky; Emon would be
guaranteeing work on a project over which it had no control. ld. at 143, lines 13-25 and at 144, lines 1-4.
Accordingly, by late 2001, the effort to sell NEPCO was abandoned. ld. at 73, lines 18-22.
)
-27~
Moreover, in most cases each invoice was reviewed by the customer's
independent engineer to ensure that the claimed milestone was in fact achieved. 82 For
many projects the lender involved in the project also had its own independent engineer
determine whether the milestone was achieved.
Thus, even if NEPCO had issued
invoices improperly in an attempt to accelerate collection of cash from its customers,
those customers would have known that the milestones reflected on the invoice were not
yet achieved and would not have paid on those invoices. Tn addition to the practical
impossibility of attempting to advance collections, there is no indication that any such
acceleration was contemplated, attempted or occurred.
There also is no evidence that NEPCO or Enron made any effort to delay
payments to vendors or subcontractors, or otherwise decrease the NEPCO Entities' use of
CMS funds or that Enron forced or pressured NEPCO to enter into EPC contracts as· a
financing tool for Enron. 83
Net Contribution by NEPCO During 2001
During 2001,84 NEPCO transferred more than $1.720 billion to the CMS. During
the same period, NEPCO received from the CMS more than $1.401 billion in the form of
payments made by the CMS for the benefit of NEPCO. Thus, during the first eleven
months of 2001, NEPCO was a net contributor to the CMS of approximately $319
million.
82
NEPCO's cash receipts for 2001 by month are set forth on the attached
Hattery Interview.
There is no evidence that Euron was encouraging NEPCO to enter into, or that NEPCO was entering
into, EPC contracts merely because they would, initially, generate positive cash flows. To the contrary,
when in the fall of 2001 Euron analyzed the possibility of selling NEPCO, Euron appeared to be surprised
by NEPCO's rapid growth and concerned about whether NEPCO would be able to perform adequately on
all of its contracts. Detrnering Depo., at 22, lines 21-25.
83
84
January 1,2001 through November 30,2001.
-28-
Exhibit 2, and its cash receipts by customer for 2001 are shown on the attached Exhibit 3.
During this same period - January through November 2001 - NEPCO's net intercompany balance with Enron increased by $305 million, from a beginning balance of $83
million to a balance on the eve of the Enron Petition Date of$388 million. This increase
of $305 million in the inter-company receivable due to NEPCO from Enron reflects
NEPCO's $319 million net cash contribution to the CMS, less approximately $14 million
of inter-company assessments for overhead, taxes and similar indirect expenses.
The Examiner has focused upon 2001 because, among other reasons, NEPCO's
inter~company receivable balance increased from $83 million to $388 million. 85
NEPCO's increased positive cash flow in 2001 appears to be the result of
NEPCO's growing business and the timing of the payments NEPCO received under its
EPC contracts. For example, at the end of 2000, NEPCO obtained two large EPC
contracts:
TECOlPanda projects in Gila River, Arizona and El Dorado, Arkansas.
During 2001, when performance under these EPC contracts began, NEPCO received
substantial milestone payments related to these two projects. As of November 2001,
these two new projects alone generated $447 million of receipts, or approximately 25%
ofNEPCO's total receipts for the year.
Affidavit of G. Brian Stanley
In connection with the filing of their bankruptcy petitions, the NEPCO Debtors
submitted the Stanley Affidavit, which identified an amount of cash "swept" from the
NEPCO Debtors by Enron as one of the events causing the NEPCO Debtors to become
In addition, a detailed analysis of years prior to 2001 would not alter the ultimate conclusions expressed
.'
in this Report.
85
-29-
insolvent. 86 Mr. Stanley's affidavit states that as of the Enron Petition Date, Enron had
swept approximately $360 million ofthe NEPCO Debtors' cash.
The Stanley Affidavit was relied upon by certain of the Claimants requesting the
appointment of an examiner. 87 Indeed, certain of the Claimants apparently understood
the Stanley Affidavit to mean that approximately $360 million was swept by Enron
"shortly before" the Enron Petition Date. 88 As discussed in this Report, that belief is
incorrect; cash was swept from NEPCO's account daily over the course ofNEPCO's
almost five year relationship with Enron.
The amount of swept cash identified
explanation.
III
the Stanley Affidavit .also merits
When interviewed, Mr. Stanley stated that a spreadsheet prepared by
NEPCO's Chief Financial Officer, Keith Marlow, was the source for his conclusion that
$360 million had been swept by Enron. 89 The spreadsheet provided by Mr. Stanley in
response to the Examiner's request for the documentary basis for his affidavit does not
reflect $360 million of the NEPCO Cash that was purportedly swept. 90 Mr. Marlow,
when interviewed by representatives of the Examiner, could not identify how Mr. Stanley
had reached the figure of $360 million from the spreadsheet. 91 Mr. Stanley does not
recall specifically how he arrived at the figure set forth in his affidavit. 92
86
Stanley Affidavit ~ 20.
Transcript of Sept. 19,2002 hearing on Goldendale Energy, Inc. 'g Motion to Appoint Examiner, at 103,
lines 7-12.
87
88
[d.
89
Stanley Interview.
90
Spreadsheet entitled "NEPCO Project Cash Analysis as of November 28,2001" [AB0301 00037].
91
Marlow Interview.
92
Stanley Interview.
-30-
E.
Tracing NEPCO's Cash
The cash contributed by NEPCO into the CMS can be traced, using the lowest
intermediate balance rule,93 at least to the Citibank concentration account. Beyond the
Citibank concentration account, however, tracing the funds becomes extremely difficult.
As discussed in Appendix A (Applicable Legal Standards), the lowest
intermediate balance rule is a legal fiction used by courts to assist trust beneficiaries who
would otherwise lose the ability to trace trust funds as a result of commingling. The rule
permits courts to presume that when trust funds are commingled with non-trust funds, the
trust funds are used last as the commingled account is drawn down. This preserves, to
the extent possible, the property subject to the trust res for the beneficiary. Thus, the
funds over which NEPCO seeks to assert a constructive trust are presumed to be used last
from the commingled funds in the CMS.
The Examiner concludes that the combination of four accounts in the eMS - the
concentration accounts at Bank of America and Citibank and the related overnight
investment accounts into which both concentration accounts were swept
.~
are the
appropriate "accounts" into which NEPCO could trace its funds because all other CMS
accounts are automatically zero balanced into one of these concentration accounts each
day and the concentration accounts, in turn, are then transferred into the overnight
investment accounts. 94
It is the Examiner's view that in the context of a cash
management system such as the CMS, to the extent that the aggregate balance in these
93
See Appendix A (Applicable Legal Standards).
See discussion below relating to the November 30th Minimal Balance for an exception to this automatic
-'
zero balancing practice.
94
-31-
four accounts remains above the value ofNEPCO's putative res, the lowest intermediate
balance rule is satisfied. 95
Critical Facts
The Examiner's analysis of the tracing issue centers on three critical facts: (i) the
September 1ih Negative Balance; (ii) the Net Consumer Status of NEPCO during the
period from September 12,2001 through the Enron Petition Date; and (iii) the November
30th Minimal Balance.
September 1i
h
Negative Balance. The cash balance in each relevant account in
connection with the September 1ih Negative Balance is set forth in the following chart:96
The Examiner acknowledges that there may be disagreement regarding whether it is appropriate to use
the aggregate amount of cash in the four CMS accounts to determine, at any point in time, if the res has
been extinguished. Using the aggregate balance of these accounts could either assist or hinder NEPCO's
ability to establish a res, depending upon the date in question. As discussed more fully in Appendix A
(Applicable Legal Standards), case law outside of the cash management system context supports the
proposition that a party seeking to impose a constructive trust cannot simply aggregate the amounts in all of
the debtor's separate accounts. See Conn. Gen'l. Life Ins. v. Universal Ins., 838 F.2d 612 (1st Cir. 1988).
The Examiner believes that this reasoning is inapplicable to a cash management system such as the CMS
because the CMS accounts were part of an integrated system that caused the amounts in each account
within the system automatically to be swept into one another on a daily basis. There is case law that
appears to take into consideration the integrated nature of a cash management system when analyzing
constructive trusts. See American Hull Ins. Syndicate v. United States Lines, Inc. (In re United States
Lines, Inc), 79 B.R. 542 (S.D.N.Y. 1987), where the court recognized that funds deposited into overnight
accounts and redeposited at the beginning of the next day would not dissipate the accounts so as to destroy
the res. However, the Examiner is unaware of any published decisions that directly address the aggregation
issue presented by the CMS. Applying a non-aggregation rule in this context could yield strange results.
For example, as depicted in the chart below, the September 12th Negative Balance of $238.2 million
resulted from the Citibank concentration account's $261.8 million negative cash position. On this date,
however, the Bank of America collection account and overnight investment account had positive cash
balances of approximately $2.6 million and $21.0 million, respectively, for a total of approximately $23.6
million. However, there were several dates between September 12, 2001 and the Enron Petition Date when
the Bank of America collection account had a negative cash position (and the related overnight investment
account had a zero balance) but the Citibank collection account had a positive cash balance. Depending
upon the date that is chosen, therefore, in order to preserve the res, NEPCO would have to take the position
that it has the choice between any of the accounts while ignoring the huge negative cash balances in the
other accounts. The Examiner believes this position is inconsistent with the general equitable notions of
tracing in the context ofa constructive trust.
95
96
Accounting Professionals' Analysis [AB0507 01350-AB0507 01355].
-32-
9/12/2001
Enron Corp.
Bank of
America
Concentration
Account
3750494015
$2,651,598
Enron Corp.
Bank of America
Overnight
Investment
Account
$21,020,993
Enron Corp.
Citibank
Concentration
Account
00076486
$(261,839,584)
Enron Corp.
Citibank
Overnight
Investment
Account
$0
Total
$(238,166,993)
The CMS was overdrawn $238 million on September 12, 2001 due to an overdraft of
$262 million in the Citibank concentration account. 97 Accordingly, as of September 12,
2001, the Examiner has concluded that any funds over which NEPCO could assert a
constructive trust were depleted in their entirety and only funds .contributed by NEPCO
subsequent to September 12,2001 could form the basis of a constructive trust res. This
conclusion, coupled with the Net Consumer Status of the NEPCO Entities from
September 12, 2001 through the Enron Petition Date, leads the Examiner to conclude that
(i) NEPCO's ability to trace a trust res is extinguished on September 12,2001 and (ii) no
unjust enrichment occurred after this date.
November 30th Minimal Balance. Assuming arguendo there was still a res in
existence after September 12, 2001, and assuming arguendo that some unjust enrichment
existed, the events occurring on November 29 and 30, 2001, which resulted in the
November 30th Minimal Balance, effectively limit the res to approximately $23 million.
On November 29, 2001, Citibank disabled the daylight overdraft, zero balancing
function of all Enron Citibank accounts linked to the CMS.98 As a result, funds that were
deposited after November 29,2001 directly into the Citibank step accounts were not zero
On September 12, 2001, Emon had approximately $25 million in an investment account at Merrill
Lynch (the "Merrill Investment Account"). The Merrill Investment Account was not part of the CMS, but
was an identifiable asset to which, at least theoretically, NEPCO could attempt to trace funds for its
constructive trust. Even including the Merrill Investment Account, however, Emon was still overdrawn on
September 12, 2001 by approximately $213 million.
97
98
Perkins January 29 Interview; Perkins March 12 Interview.
-33-
balanced into the Citibank concentration account. On November 30, 2001, the Enron
Treasury Department manually transferred funds into certain of the Citibank
disbursement accounts so that the accounts could be used to satisfy that day's obligations.
In addition, the Treasury Department transferred $32.5 million (representing a portion of
certain proceeds received by two Enron subsidiaries under a $1 billion financing related
to Enron's pipeline business) plus an additional $1 million (representing funds from
another Enron subsidiary unrelated to NEPCO) from three non-CMS accounts into four
CMS accounts at Citibank. 99
th
The cash balance of each relevant account in connection with the November 30
Minimal Balance is set forth in the following chart: lOO
11130/2001
Enron Corp.
Bank of
America
Concentration
Account
3750494015
$2,549,423
Enron Corp.
Bank of
America
Overnight
Investment
Account
$0
Enron Corp.
Citibank
Concentration
Account
00076486
$(773,413)
Enron Corp.
Citibank
Overnight
Investment
Account
$1,645,425
All other
EnronCMS
Accounts
$52,897,231
Total
$56,318,666
On November 30, 2001, the available funds in the entire CMS were reduced to
approximately $56.3 million.
However, of this $56.3 million, approximately $33.5
million (i.e., the $32.5 million from the pipeline financing plus the additional $1 million)
consisted of funds in accounts linked to the CMS, but not part of the commingled funds
that could be arguably included in NEPCO's potential res. lOI Accordingly, of the $56.3
million in the CMS on November 30,2001, only $23 million is susceptible of being part
99
100
Accounting Professionals' Analysis [AB0507 01349].
Accounting Professionals' Analysis [AB0507 01350 - AB0507 01355].
101 Since these funds (i) are not funds that came from a source which contained NEPCO commingled funds
and (ii) were deposited into accounts that did not contain, as of November 30, 2001, any NEPCO
commingled funds, the Examiner has concluded that these funds are not subject to an attempt by NEPCO to
)
trace them.
-34-
of any potential res. This potential $23 million res, of course, is available only if the
September 12th Negative Balance and the subsequent Net Consumer Status of NEPCO
are not dispositive.
Ability to Trace Outside the eMS
The Claimants may contend that the NEPCO Debtors should be permitted to
attempt to trace funds that may have been moved by Enron out of the CMS into other
bank accounts not affiliated with the CMS, or to non-cash assets of Enron. There are no
reported decisions directly on point. 102 However, such an effort would be extremely
expensive and very complicated. Of the approximately 1400 bank accounts in which
Enron had an interest prior to its bankruptcy, fewer than 200 were part of the CMS. The
remaining bank accounts .are in some instances accounts held jointly with other entities or
accounts, for example international accounts, unaffiliated with the CMS. 103 As a result,
there may be confidentiality issues, currency translation issues and issues arising under
the laws of foreign jurisdictions which would complicate the audit process.
An audit of each account would be required to determine if any funds from the
CMS, and thus funds to which NEPCO theoretically could trace a res, were moved into
these non-CMS accounts. Not only would each deposit in these accounts need to be
identified, but also once identified each deposit would have to be traced back to its source
to see if it came from an account with CMS funds in it. The Examiner's accountants
estimate that this audit would cost between $2 million to $5 million and take from six to
eight months. The estimate does not, because it cannot, address potential delays that may
102
See discussion at footnote 30.
10~ The ruling by the District Court in In re Drexel suggests that an attempt to trace into such joint accounts
)
would not be permitted.
-35-
occur in translating accounts from foreign currencies and languages, the inherent delays
that occur when trying to obtain data from less developed countries, and other issues of a
like nature that may arise.
-36-
III.
NEPCO'S POST-PETITION ACTIONS
A.
Impact of Enron's Bankruptcy Filing
In the weeks preceding Enron's bankruptcy petition, NEPCO's customers became
concerned about NEPCO's ability to continue its operations and the value of the
guarantees they had obtained from Enron with respect to the EPC contracts. 104
NEPCO's management commenced negotiations with its customers to ensure that
construction would not stop on the projects. lOS
The EPC contracts were revised,
converting the lump sum, turnkey, milestone based contracts to simple cost recovery
contracts so that the customers would pay only NEPCO's (and other NEPCO Entities')
actual administrative expenses in continuing to build the power facilities. 106
customers insisted upon paying vendors and suppliers directly.
The
The customers also
refused to pay any additional funds into an account over which Enron had any contro1. 107
Thus, after the Enron Petition Date, all payments to NEPCO were made into bank
accounts opened by NEPCO at Frontier Bank in Bothel, Washington. lo8
It became immediately apparent, however, that the use of Enron's payroll
facilities would be necessary.
NEPCO had neither the expertise, personnel nor
equipment to process payroll on its projects. Accordingly, Enron continued to process
104
GillislDaniels Interview.
105 Once construction on a power plant is stopped, it is diffkult to recommence construction. For example,
the skilled trades workers leave in search of other employment and getting a skilled work force to return
upon the recommencement of construction is both time consuming and expensive. In addition, both the
owners and NEPCO were concemed about the safety hazards and other potential liabilities associated with
a half-completed power plant construction site. GillislDaniels Interview; Hattery Interview.
106 See Restated Amendment No.1 to Turnkey Engineering, Procurement and Construction Agreement
dated as of June 27, 2000 by and between Ouachita Power, LLC and National Energy Production
Corporation [AB0294 00027-AB0294 00033].
107
GillislDaniels Interview.
108
Cranmer Interview.
-37-
NEPCO's payroll as it had done in the pre~bankruptcy period. However, under Enron's
debtor-in-possession financing order,109 Enron was not allowed to advance payroll funds
to NEPCO. Rather, NEPCO was required to pre-fund the payroll to Enron, which Enron
then processed and issued to NEPCO's employees.
This pre-funding requirement
necessitated obtaining from the customers, on a weekly basis, funding in the exact
amount of that week's payroll, then wire transferring that amount from NEPCO's
Frontier Bank account to Enron so that Enron would fund the payroll.IID
Thus, in the immediate aftermath of Enron's bankruptcy, NEPCO (i) renegotiated
the EPC contracts of its customers, converting them from milestone contracts into cost
recovery contracts, (ii) allowed its customers to pay suppliers and vendors directly,
(iii) invoiced the customers only for that customer's share of NEPCO's general and
administrative expenses, and (iv) arranged for the customers to pre-fund payroll and for
Enron, after receiving the funds from the customers, to disburse payroll. No cash was
contributed by the NEPCO Debtors to Enron post-petition.
After renegotiating its EPC contracts with its customers and taking the other steps
outlined above, NEPCO recognized that it could not survive long unless it was acquired
by an entity with the .adequate financial wherewithal to fund its continuing operations and
provide the necessary guarantees to enable it to obtain new business. III
109 Interim Order Authorizing Debtors to Obtain Post-Petition Financing Pursuant to 11 U.S.C. §§ 105,
361, 362, 364(c)(1), 364(c)(2), 364(c)(3) and 364(d)(1) and Scheduling Final Hearing Pursuant to
Bankruptcy Rule 4001(c), Dec. 3, 2001, DocketNo. 63.
110
Cranmer Interview.
1Il
Detmering Depo., at 74, lines 11-19.
-38-
Therefore, NEPCO's management, consisting of its President, John Gillis, and
four of his senior managers (the "NEPCO MBO Group"),112 attempted to structure a
management-led buy-out of NEPCO.
However, both the NEPCO MBO Group and
Enron's management soon recognized that a sale of NEPCO would be extremely
difficult. I13 A major impediment to the sale ofNEPCO was, as discussed above, the fact
that NEPCO's projects would not be profitable for a new contractor since NEPCO had
"frontloaded" the milestone payments under the .contracts. A new .contractor would have
to expend more funds to complete the projects than remained to be paid under the EPC
Contracts. I 14 No new contractor would do so without additional payment from the
owners. 115
Moreover, only a purchaser with sufficient financial strength to issue future
guarantees on behalf ofNEPCO would be a viable purchaser because, in order to have
any going concern value, NEPCO would have to demonstrate the ability to continue to
obtain new projects. 1l6 Without guarantees from a well-financed parent company, it
would be much more difficult for NEPCO to obtain future construction projects. Il7
112 The four senior managers in the NEPCO MBO Group were Steven Daniels, David Lund, Daniel Haas
and Mike Rantz.
113 In February 2002, the NEPCO MBO Group was placed on administrative leave by Enron for two
reasons. First, their activities in pursuing the buy-out caused a potential conflict of interest with their
continued day-to-day management ofNEPCO. Second, a dispute arose between Enron's management and
the NEPCO MBO Group, or at least Mr. Gillis, over a $2 million series of bonus payments to NEPCO
employees not authorized by Enron. Stanley Interview. None of these issues are addressed in this Report.
114
Detrnering Depo., at 63, lines 3-6; Marlow Interview.
115
Marlow Interview.
116
DetrneringDepo., at 36, lines 14-21.
117
[d. at 60, lines 19-25 and at 61, lines 1-20.
-39-
B.
SNC-Lavalin Transaction
In approximately late January or early February 2002 - in the immediate
aftermath of Enron's Petition Date - many ofNEPCO's customers informed NEPCO of
their desire that
SNC~Lavalin
Constructors, Inc. ("SNC'') replace NEPCO as general
contractor on their projects. I 18 SNC, for the reasons discussed above, was unwilling to
purchase the contracts from NEPCO. SNC was willing, however, to take over some of
NEPCO's projects under renegotiated contracts with the customers. 1l9 SNC needed the
expertise of NEPCO's employees to be able to take over as_ general contractor on these
projects. 120 As a result, SNC and Enron commenced negotiations for SNC to purchase
certain ofNEPCO's assets and retain virtually all of its employees. l21
On May 14,2002, NEPCO .and SNC entered into an Asset Purchase Agreement
(the "SNC Asset Purchase Agreement") pursuant to which NEPCO agreed, subject to the
Court's approval, to sell to SNC certain assets and properties for $400,000. 122 On May
21, 2002, the day after seeking bankruptcy protection, NEPCO filed a motion seeking
approval by the Court to sell certain assets and properties to SNC (the "Sale Motion").123
Concurrent with its Sale Motion, NEPCO filed a motion seeking, among other things, an
118
GillslDaniels Interview.
119
[d.
120
[d.
121
[d.; Stanley Interview.
122 Asset Purchase Agreement by and between National Energy Production Corporation and SNC-Lavalin
Contractors, Inc. dated as of May 14, 2002 [AB0252 04110-AB0252 04323].
123 Motion of National Energy Production Corporation for an Order, Pursuant to Sections 105, 363, 365
and 1146 of the Bankruptcy Code and Federal Rule of Bankruptcy Procedure 6004, Authorizing and
Approving (A) the Terms and Conditions of Agreement for the Sale of Certain Assets and the Assumption
and Assignment of Certain Contracts by Movant to SNC-Lavalin Constructors Inc., and (B) Authorizing
-'
the Consummation ofthe Transactions Contemplated Therein, May 21,2002, Docket No. 3912.
~40~
order authorizing and scheduling an auction at which NEPCO would solicit higher and
better bids for the assets.
A number of objections as to the adequacy of the .consideration given to NEPCO
under the proposed sale were filed, and limited discovery on those issues occurred. The
Court approved the sale on September 5, 2002 (the "SNC Transaction") reserving,
however, the rights of the objecting parties to seek damages from NEPCO and/or SNC
resulting from the sale. 124
124 Order, Pursuant to Sections 105, 363, 365 and 1146 of the Bankruptcy Code and Bankruptcy Rule
6004, Authorizing and Approving (A) The Terms and Conditions of Agreement for the Sale of Certain
Assets and the Assumption and Assignment of Certain Contracts by National Energy Production
Corporation to SNC-Lavalin Constructors Inc. and (B) Authorizing the Consunnnation of the Transaction
Contemplated Therein, Sept. 5,2002, Docket No. 6321.
)
-41-
IV.
CONCLUSIONS AND RECOMMENDATIONS
A.
Conclusions
As set forth herein, the Examiner concludes that the sweep of the NEPCO Cash
into the CMS, rather than occurring on the eve of Enron's bankruptcy, occurred every
day, pursuant to Enron's Treasury Policy, as the CMS accounts were zero balanced into
the concentration accounts at Bank of America and Citibank. The .amounts of NEPCO
Cash swept by the CMS varied each day depending upon the amount of funds, if any,
deposited into NEPCO's collections account. The net NEPCO Cash swept into the CMS
in 2001 was $319 million from January 1,2001 until the Enron Petition Date, but during
the period from September 12,2001 to the Enron Petition Date, the NEPCO Entities were
net consumers of approximately $57 million from the CMS. The Examiner has found no
evidence of fraud, malfeasance or other wrongdoing by either NEPCO or Enron in
connection with the CMS. Rather, Enron used the CMS as a method to maximize its
return on cash assets.
NEPCO's participation in the CMS was no different than
substantially all ofthe other domestic wholly owned affiliates ofEnron.
The Examiner concludes that the legal and factual predicates for the imposition of
a constructive trust by NEPCO are not present. Specifically,
•
The Examiner has not discovered any false representations made by Enron
to NEPCO with respect to its participation in the CMS, or any other facts
that suggest that Enron defrauded NEPCO or the other NEPCO Entities
through the use of the CMS. Rather, NEPCO participated in the CMS in
the same manner as substantially all other domestic wholly owned
affiliates ofEnron.
•
There is nothing to suggest that there was any other relationship, including
the CMS arrangements, that as a matter of law would establish a formal
fiduciary relationship or a relationship of special trust or confidence
between Enron and NEPCO.
-42-
B.
•
The Examiner does not believe that the participation by NEPCO in the
CMS, even though it may have resulted in a net balance in Enron's favor
as of the Enron Petition Date, would be considered under applicable case
law to be "unjust enrichment" ofEnron.
•
NEPCO cannot satisfy the tracing element because the res was
extinguished on September 12, 2001 and no additional res was created
subsequent to that date because of the Net Consumer Status of the NEPCO
Entities.
Recommendations
Pursuant to the December 6th Order, the Examiner makes the following
recommendations with respect to the NEPCO investigation:
Additional Tracing ofNon eMS Accounts
Because of:
(i) the Examiner's conclusion that NEPCO would be unable to
establish the first two elements of a constructive trust and (ii) the time, expense and
uncertainty involved in tracing accounts and other assets which are not part of the CMS,
the Examiner recommends that no further tracing be conducted by the Examiner.
-43-
Additional Issues
In accordance with the December 6th Order, the Examiner has not analyzed the
issues raised by certain of the Claimants regarding the
post~petition
conduct of NEPCO,
the NEPCO MBO Group and SNC in connection with the SNC Transaction or other
issues raised by the Claimants (except to the extent specifically covered by this Report).
After the comment period contemplated by the December 6th Order, the Examiner will
await direction from the Court as to whether any further investigation relating to NEPCO
IS
necessary.
Dated: April 7, 2003
Respectfully submitted,
/s/ Neal Batson
Neal Batson
Examiner
ALSTON & BIRD LLP
One Atlantic Center
1201 West Peachtree Street
Atlanta, Georgia 30309-3424
404881-7000
~44~
UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK
----------------------------------------------------- J(
In re:
Chapter 11
ENRON CORP., et al.,
Case No. 01-16034 (AJG)
Debtors.
Jointly Administered
-----------------------------------------------------
](
EXHIBITS 1-3
to
REPORT OF NEAL BATSON, COURT-APPOINTED EXAMINER, IN
CONNECTION WITH THE EXAMINATION OF NATIONAL ENERGY
PRODUCTION CORPORATION PURSUANT TO COURT ORDER
DATED DECEMBER 6,2002
EXHIBIT 1
ENRON CASH MANAGEMENT SYSTEM
BANK ACCOUNTS AS OF NOVEMBER 30,2001
IThe Protane Corporation
mon Hydrocarbons Marketing Corp.
nron Finance Corp
mon Corp.
IEnron Corp.
ranswestem Pipeline Company
mon Engineering & Construction Company
NACash-EGM
mon Gas Liquids, Inc.
nron Metals And Commodity Corp.
mon Industrial Markets LLC
nron North America Corp. - FP Financial
IGarden State Paper Company, LLC
NA Upstream Company, LLC
mon Freight Markets Corp.
ESO Merchant Investments, Inc.
mon Energy Services North America, Inc.
mon North America Corp. - Steel Financial
mon North America Corp. - Steel
PI Cash Services
WS EES Cash Services
orthem Plains Natural Gas Company
SWEE'P, L.L.C.
orthem Natural Gas Company
'~IEmon Broadband Services, Inc.
mon Trailblazer Pipeline Company
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
37504943291
3750469105
37504947721
3750494015
3750494028
37504942061
3750469309!
3751443308
1295228515
3751520441
37515204701
3751820251
375173231
3751777485
3751777472!
3751790035
3751242758
375182026
3751820277
3751826035
3751827238
3750494183
37504940991
375049417
375144332
3750494138
(Continued)
ENRON CASH MANAGEMENT SYSTEM
BANK ACCOUNTS AS OF NOVEMBER 30,2001
IClinton Energy Management Services, Inc.
uron Transportation Services Company
mon Energy Services Operations, Inc. - Dublin
an Border Gas Company
mon Energy Services Capital Corp.
mon North America Corp.
nron Reserve Acquisition Corp.
mon North America Corp. - Admin
nron Clean Fuels Company
mon Facility Services, Inc.
GP Fuels Company
nron North America Corp. - Access
nron Global Markets - EGM Reporting Entity ENA
nron Liquid Fuels, Inc.
ouisiana Resources Company
ouisiana Gas Marketing Company
RCI, Inc.
nron Fuels International, Inc.
oint Energy Development Investments L.P.
NA Cash Services
P Services Corporation
nron North America Corp. - FP
nron Power Marketing, Inc.
IGulfCoast Operations, Div Enron Operations L.P.
ES Cash Services
nron Capital Resources, L.P.
BS Cash Services
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
375125771
37504954541
3751257727i
3751242761
3751732763
3750494727i
3750495001
3750469477i
3750494992
37513119641
3750472079
3750469529
3751443337
37504691341
3750472244
3750472231
3750472273
3750472671
37504691501
3751204275
37504691891
375148028
37504693121
3750062706,
3751204301
3750469532;
375144334
I
(Continued)
ENRON CASH MANAGEMENT SYSTEM
BANK ACCOUNTS AS OF NOVEMBER 30,2001
ECC Cash Services
[Calme Cash Services
NACash-EIM
TS Cash Services
nron Broadband Services, L.P.
nron Power Marketing, Inc. - Retail
nron Power Marketing, Inc. - Retail
nron Capital Management II L.P.
nron Capital Management III L.P.
mon Energy Information Solutions, Inc.
PC Estate Services, Inc. [NEPCO]
IOperational Energy Corp.
mon Energy Services Operations, Inc.
IECT Investing Partners, L.P.
mon Corp.
monCorp.
mon Corp. - Insurance (CIGNA Funding)
nron Corp. - Insurance (CIGNA Funding for NEPCO)
nron Corp.
ranswestem Pipeline Company
NACash-EGM
mon Metals And Commodity Corp.
NW Cash Services
barden State Paper Company, LLC
nron Energy Services North America, Inc.
PI Cash Services
WS EES Cash Services
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Bank of America
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
3751311977,
3751480248
37515204671
3751204288
37517327761
3751480264
3751480277
3750858596
37509971301
3751240970
3751311948
3751311951
3751520438
37508585701
39109839
39109847
40802462
30411812i
39109855
3910999
3861656
38633081
38631705
38633401
385825361
38643052!
38646173
(Continued)
ENRON CASH MANAGEMENT SYSTEM
BANK ACCOUNTS AS OF NOVEMBER 30,2001
orthem Natural Gas Company
!Clinton Energy Management Services, Inc.
mon North America Corp. - Consolidated Billing
NA Cash Services
ES Cash Services
BS Cash Services
ECC Cash Services
dia Cash Services
SA Cash Services
lCalme Cash Services
pachi Cash Services
NACash-EIM
TS Cash Services
mon Property & Services Corp.
urope Cash Services
Services Corp.
EDC Cash Services
GEP Cash Services
mon Energy Services Operations, Inc.
monCorp.
uron Power I (Puerto Rico), Inc.
'ranswestem Pipeline Company
mon Engineering & Construction Company
NACash-EGM
mon Metals And Commodity Corp.
OTT Energy Corp.
mon Equipment Installation Company
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank Delaware
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
39109951
38582528
38554252i
38621208
386212241
38616476
38611181
38611245
386112291
38611173
38611165
38611237
38621216'
38570201
3857665
38579265
38597375
38597412
38573402
000764861
40734447
304547161
40668283
30420778
3043514
38383692
4070709
,
(Continued)
ENRON CASH MANAGEMENT SYSTEM
BANK ACCOUNTS AS OF NOVEMBER 30,2001
NW Cash Services
Garden State Paper Company, LLC
Star VPP, LP
PI Cash Services
WS EES Cash Services
orthem Natural Gas Company
IClinton Energy Management Services, Inc.
nron North America Corp. - Consolidated Billing
nron Energy Services, Inc. - Dublin
mon Energy Services Operations, Inc. - Dublin
Superior Construction Company
mon Power Corp
Smith Street Land Company
ingtec Constructors L.P.
mon Wind
oint Energy Development Investments L.P.
NA Cash Services
mon Power Construction Co. - Mexico
ES Cash Services
BS Cash Services
ECC Cash Services
dia Cash Services
SA Cash Services
ICalme Cash Services
. pachi Cash Services
NA Cash-ElM
mon Eauioment Procurement Comoany
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
30435128
30440445
30454783
30462388
304696941
30454708
40756179i
40726308
407410221
407524421
40769711
407869091
40797982
40795493
304698541
40655378
40781075
407524341
40781083
40800301
40807423
40807431
40807458
408074661
40807474
40807482
40707078
I
(Continued)
ENRON CASH MANAGEMENT SYSTEM
BANK ACCOUNTS AS OF NOVEMBER 30,2001
nron Equipment Procurement Company
TS Cash Services
CT Investments, Inc.
mon Property & Services Corp.
mope Cash Services
Services Corp.
EDC Cash Services
GEP Cash Services
nron Onshore Procurement Company
nron Leasing Partners, L.P.
nron Energy Services Operations, Inc.
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
Citibank New York
401073421
40781091
40695791
4073440
40745875
40752477
40786941
40800379
407071071
40721339
4074099
EXHIBIT 2
NEPCO CASH RECEIPTS
BY MONTH
January 2001 through November 2001
JANUARY
75,179,942
FEBRUARY
51,787,371
MARCH
129,316,115
APRIL
107,911,254
MAY
122,073,451
JUNE
278,461,626
JULY
169,367,838
AUGUST
318,246,089
SEPTEMBER
124,785,357
OCTOBER
297,018,279
NOVEMBER
45,836,785
EXHIBIT 3
NEPCO CASH RECEIPTS
BY CUSTOMER
January 1,2001 through November 30,2001
Cogentrix
Green Country
Ouachita
Southhaven
Caledonia
93,729,720
142,011,385
70,512,710
61,196,461
TECO
McAdams
Dell
124,155,579
117,837,464
TECO/Panda
EI Dorado
Gila River
249,370,739
197,731,327
AESWolfHollow
Lake Worth
84,347,254
16,266,700
Avista
Coyote Springs
68,506,089
East Coast Power
Linden 6
28,173,508
NRG
Kendall (JV wIDick Corp.)
Nelson (JV w/PCL)
37,262,824
81,175,222
Calpine
Goldendale
Black Hills Energy
Fountain Valley
Overland Contr. Inc
Payne Creek
4,797,096
Austin Energy
Sand Hills
7,458,758
Brazil Power Development
TrustlSociedade Flumminense
de Ener .a Ltda
Electrobolt
172,704,079
Micellaneous
Cash receipts not
specifically identified with a
Pro·ect
103,936,221
40,891,173
UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK
-----------------------------------------------------
](
In re:
Chapter 11
ENRON CORP., et ai.,
Case No. 01-16034 (AJG)
Debtors.
Jointly Administered
-----------------------------------------------------
](
APPENDIX A
(Applicable Legal Standards)
to
REPORT OF NEAL BATSON, COURT-APPOINTED EXAMINER, IN
CONNECTION WITH THE EXAMINATION OF NATIONAL ENERGY
PRODUCTION CORPORATION PURSUANT TO COURT ORDER DATED
DECEMBER 6, 2002
Reference is made to the preceding Report of Neal Batson, Court-Appointed
Examiner, in connection with the Examination of National Energy Production
Corporation Pursuant to Court Order Dated December 6, 2002 (the "Report"). This
Appendix constitutes an integral part of the Report. All capitalized tenns not otherwise
defined herein shall have the meanings set forth in the Report.
TABLE OF CONTENTS
I.
IN"TRODUCTION
1
II.
CHOICE OF LAW
2
III.
ELEMENTS OF CONSTRUCTIVE TRUST UNDER TEXAS LAW
A.
Overview
B.
Actual Fraud or Breach of Duty
C.
Unjust Enrichment
D.
Tracing the Res
5
5
5
10
14
IV.
BANKRUPTCY LAW IMPACT ON CONSTRUCTWE TRUSTS
19
I.
INTRODUCTION
This Appendix A (Applicable Legal Standards) discusses: (i) the choice of law
principles applicable to the assertion of a constructive trust against a debtor in
bankruptcy; (ii) the requirements of Texas law applicable to the imposition of a
constructive trust; and (iii) some recent cases - not in the Second Circuit - that have
refused to enforce a constructive trust against a debtor in bankruptcy.
II.
CHOICE OF LAW
As a general rule, bankruptcy courts look to state law to determine whether to
impose a constructive trust. l In considering which state's substantive law to apply, the
Second Circuit Court of Appeals has held that a bankruptcy court should apply the choice
oflaw rules of the forum state unless important federal bankruptcy policy is implicated.2
New York, the forum state here, applies the law of the state with the greatest interest in
the dispute. 3 The facts or contacts which define state interests are those which relate to
the purpose of the particular law in conflict. 4 In the case of Krock v. Lipsay,5 the Second
Circuit Court of Appeals stated that
'~here
the parties are domiciled in different states,
the locus of the tort will almost always be determinative in cases involving conduct-
I Sanyo Electric, Inc. v. Howard's Appliance Corp. (In re Howard's Appliance Corp.), 874 F.2d 88,93 (2d
Cir. 1989) (stating that the court must look to state law to determine whether to impose a constructive trust
on property of the estate); Conn. Res. Recovery Auth. v. Enron Corp. (In re Enron Corp.), No. 01-B-16034
(AJG),2003 WL 1571719 (Bankr. S.D.N.Y. Mar. 27, 2003). See also Haber Oil Co. v. Swinehart (In re
Haber Oil Co.), 12 F.3d 426, 435 (5th Cir. 1994) ("[I]n the absence of controlling federal bankruptcy law,
the substantive nature of the property rights held by a bankrupt and its creditors is defmed by state law.").
Where federal interests are involved, such as the FCC's regulatory distribution of federal funds, the federal
common law of constructive trusts has been applied. See, e.g., City ofSpringfield v. Lan Tamers, Inc. (In
re Lan Tamers, Inc.), 281 B.R. 782 (Bankr. D. Mass. 2002) (collecting cases). No federal interests appear
to be implicated by Enron's CMS or the NEPCO Entities' participation in it.
2
Bianco v. Erkins (In re Gaston & Shaw), 243 F.3d 599 (2dCir. 2001).
Koreag, Controle Et Revision S.A. v. Refco FIX Assocs, Inc. (In re Koreag, Controle Et Revision S.A.),
961 F.2d 341, 351 (2d Cir. 1992). The issue in Koreag was whether amounts in a bank account were
impressed with a constructive trust such that such amounts would not constitute property of the estate for
the purpose of an ancillary proceeding llnder Section 304 of the Bankruptcy Code. In making its
determination that New York law, rather than the law of Switzerland, govemed, the court considered the
principal place of business of the parties, the place of the disputed funds, and the extent of each
jurisdiction's interest in the litigation. The court determined that New York had a superior interest in
applying its laws because (i) the underlying property claims were related toa New York bank account, (ii)
the contract was performed in New York, and (iii) the conduct giving rise to the dispute occurred in New
York. In contrast, Switzerland's interest focused more upon the fair and organized administration of the
debtor's estate that was being administered in Switzerland. New York's primary interest lay in protecting
the property interests of its citizens and those who do business there and, therefore, the court applied the
substantive law of New York in determining the existence of a constructive trust. Koreag points out that
the federal common law choice oflawmle is the same as the choice oflaw rule ofNew York. Id. at 350.
3
4Id.
s 97 F.3d 640 (2d Cir. 1996).
-2-
regulating laws.,,6 Citing to Krock, this Court stated at the hearing on Enron's Motion to
Dismiss the Complaint of Westdeutsche Landesbank Girozentrale (the "Hearing") that
the "most important contacts considered are the parties' domiciles and locus of the tort,,,7
and held that, under the interests test, Texas law would apply.s NEPCO's principal place
6
/d. at 646.
Transcript of May 1, 2002 hearing on Emon's Motion to Dismiss the Complaint of Westdeutsche
Landesbank Girozentrale, at 15. (Docket No. 3983). At the Hearing, the Court also had to consider the
breadth of a choice of law provision.
7
Id. Even if Texas law does not govern, it does not appear that a different result would be reached if the
law of Delaware (NEPCO's state of incorporation), New York (principal place of business of Citibank, the
bank to which funds were ultimately transferred), Washington (NEPCO's principal place of business) or
Oregon (Emon's state of incorporation) were applied even though there are differences in some aspects of
the law. Delaware law requires a showing of (i) unjust enrichment of the defendant, (ii) fraudulent or
unfair and unconscionable conduct on the part of the defendant and (iii) the existence of a relationship in
which the defendant owed a duty to the deprived party. Adams v. Jankouskas, 452 A.2d 148, 152 (Del.
1982). Delaware requires that the claimant identify the property to which the trust is to attach. /d. Under
New York law, a party seeking to impose a constructive trust must ordinarily establish four elements: (i) a
confidential or fiduciary relationship; (ii) a promise, express or implied; (iii) a transfer made in reliance on
that promise; and (iv) unjust enrichment. LFD Operating, Inc. v. Ames Dep't Stores, Inc. (In re Ames
Dep't Stores, Inc.), 274 B.R. 600, 625 (Bankr. S.D.N.V. 2002). In New York, the imposition of such a
trust also requires (i) the entitlement to specific property; (ii) the existence of a res; and (iii) the ability to
trace the property. Am. Hull Ins. Syndicate v United States Lines, Inc. (In re United States Lines, Inc.), 79
B.R. 542,544 (Bankr. S.D.N.Y. 1987). However, as this Court noted at the Hearing, under New York law
it is possible to impose a constructive trust even in the absence of a fiduciary or confidential relationship or
a breach thereof. That is, a constructive trust can be imposed even on an innocent party holding property if
that party would be unjustly enriched by the retention of the subject property. See In re Ames, 274 B.R. at
626; but see Majutama v. Drexel Burnham Lambert Group Inc. (In. re Drexel Burnham Lambert Group,
Inc.), 142 B.R. 633, 636 (Bankr. S.D.N.V. 1992) ("If the relationship is not of a confidential or fiduciary
nature, so 'pregnant with opportunity for abuse and unfairness' as to require equity to intervene and
scrutinize the transaction, a constructive trust c.annot be imposed."). Although Washington case law does
not specifically defme the requirements for the imposition of a constructive trust, they appear to be similar
to those required by Texas. The Washington courts have considered each of the following elements as
requirements: (i) abuse of confidence, Scymanski v. Dufault, 491 P.2d 1050, 1057 (Wash. 1972) ("Equity
will raise a constructive trust and compel restoration where one through actual fraud, abuse of confidence
reposed and accepted, or through other questionable means gains something for himself which in equity
and good conscience he should not be permitted to hold"); (ii) unjust emichment ("A constructive trust
may arise even though acquisition of the property was not wrongful. It arises where the retention of the
property would result in the unjust enrichment of the person retaining it"), id. at 1058; and (iii) tracing the
res,Aebig v. Commercial Bank ofSeattle, 674 P.2d 696,697 (Wash. Ct. App. 1984) ("the claimant seeking
to obtain a constructive trust must identify specific property as the res of the trust to which she is
entitled."). Oregon requires (i) the existence of a fiduciary or confidential relationship, (ii) a violation of
that duty imposed by the relationship and (iii) unjust enrichment of the defendant. See Albino v. Albino,
568 P.2d 1344, 1351 (Or. 1977) ("[a] constructive trust arises where a person in a fiduciary or confidential
relationship acquires or retains property in violation of his duty to the grantor"). Oregon also requires that
the specific property be identified as the res. Id. In sununary, the law of all of these states requires a
finding of unjust enrichment and that specific property be identified as the res (which may be traced),
which are the second and third requirements of Texas law. The first requirement of Texas law, that there
be a breach of fiduciary duty or another relationship of trust or confidence, or fraud, is not necessarily
8
-3-
of business is the state of Washington and Enron's principal place of business is Texas.
The Hlocus of the tort" would focus on the actions .of Enron, which was headquartered in
Texas. The Examiner concurs that the substantive law of Texas governs this matter. This
Appendix sets out and applies the Texas law applicable to constructive trusts.
required by New York law (and perhaps not by Washington law). However, as discussed in greater detail
in the Report and this Appendix, the Examiner concludes that NEPCO cannot establish a constructiye trust
.
because none of the three requirements of Texas law are met.
-4~
III.
ELEMENTS OF CONSTRUCTIVE TRUST UNDER TEXAS LAW
A.
Overview
In order to impose a constructive trust under Texas law, three requirements must
be satisfied: (i) (A) actual fraud or (B) a breach of either a fiduciary relationship or a
relationship of special trust or confidence, (ii) the unjust enrichment of the wrongdoer,
and (iii) tracing the property to ares. 9
B.
Actual Fraud or Breach of Duty
Actual Fraud
To demonstrate actual fraud in Texas, one must establish six elements: (i) a
material representation; (ii) a false representation; (iii) knowledge of the false
representation at the time it was made (or that the speaker made the representation
recklessly without any knowledge of its truth and as a positive assertion); (iv) the speaker
made the representation with the intent that it be relied upon by the party; (v) the party
acted in reliance on the misrepresentation; and (vi) the party thereby suffered injury. 10
The Examiner has not discovered any false representations made by Enron to
NEPCO with respect to its participation in the CMS, or any other facts that suggest that
Enron defrauded NEPCO through the use of the CMS. Rather, NEPCO participated in
9 Swinehart v. Stubbeman, McRae, Sealy, Laughlin & Browder, Inc., 48 S.W.3d 865, 878-79 (Tex. Ct.
App. 2001); Southmark Corp. v. Grosz (In re Southmark Corp.), 49 F.3d 1111, 1118 (5th Cir. 1995)
(applying Texas law); Haber Oil Co. v. Swinehart (In re Haber Oil Co.), 12 F.3d 426, 436 (5th Cir. 1994)
(applying Texas law); Monnig's Dep't Stores, Inc. v. Azad Oriental Rugs, Inc. (In re Monnig's Dep't
Stores, Inc.), 929 F.2d 197,201 (5th Cir. 1991); Thigpen v. Locke, 363 S.W.2d 247 (Tex. 1963); see also
Tri-StateChems., Inc. v. W Organics, Inc., 83 S.W.3d 189 (Tex. Ct. App. 2002) (citing Pierce v. Sheldon
Petroleum Co., 589 S.W.2d 849, 853 (Tex. Ct. App. 1979) (stating essential requirement of equitable
remedy of constructive trust is "that the trust beneficiary must trace the equitable right asserted in an
unbroken line to the property he seeks to impress with the trust").
10
In re Haber Oil Co., 12 F.3d at 437 (citing Eagle Props., Ltd. v. Scharbauer, 807 S.W.2d 714, 72~ (Tex.
.
~~
-5-
the CMS pursuant to the Enron Treasury Policy applicable to substantially all domestic
wholly owned affiliates ofEnron.
Fiduciary Duty or Confidential or Other Special Relationship
Texas courts recognize two types of fiduciary relationships, formal and
informa1. 11 Formal fiduciary relationships are those that arise as a matter of law, such as
relationships between principal and agent, partners, and joint venturers.
Informal
fiduciary relationships (generally called confidential relationships) may arise from "a
moral, social, domestic or purely personal relationship of trust and confidence,,12 or in
cases where "influence has been acquired and abused, in which confidence has been
reposed and betrayed.,,13 Based on the facts revealed in the Examiner's investigation,
there appear to be only two potential sources to find the existence of a fiduciary
relationship or a confidential relationship: first, the parent-subsidiary relationship
between Enron and NEPCO, and second, the participation ofNEPCO in the CMS. 14
II
Swinehartv. Stubbeman, McRae, Sealy, Laughlin & Browder, Inc., 48 S.W.3d 865 (Tex. Ct. App. 2001).
12
Swinehart, 48 S.W.3dat 878-79; see also In re Monnig's Dep't Stores, Inc., 929 F.2d at 20l.
13
Swinehart, 48 S.W.3d at 878-79 (citations omitted).
14 The facts discovered by the Examiner did not suggest any other basis to find a fiduciary/confidential
relationship.
-'
-6-
Parent ~ Subsidiary Relationship
NEPCO is a Delaware corporation. The duties, if any, ofNEPCO's shareholders
to NEPCO are governed by Delaware law. 15 It is well settled under Delaware law that a
parent corporation does not owe a fiduciary obligation to its wholly owned subsidiary.16
By contrast, a parent corporation that is the majority shareholder of a subsidiary owes a
fiduciary duty to the subsidiary's minority shareholders. 17 NEPCO had no minority
shareholders and therefore, the general rule that a corporation owes no duty to its wholly
owned subsidiary appears applicable. There is nothing to suggest that there was any other
15 LaSalle Nat 'I Bank v. Perelman, 82 F. Supp. 2d 279 (D. Del. 2000) (Delaware substantive law governed
because all of plaintiffs claims concerned the conduct of officers, directors and controlling shareholders of
the Delaware corporations); BBS Norwalk One, Inc. v. Raccolta, Inc., 60 F. Supp. 2d 123 (S.D.N.Y. 1999)
(applying New York choice of law in diversity case and finding that consistent with "internal affairs
doctrine" a claim of breach of fiduciary duty owed to a corporation is governed by the law of the state of
incorporation); Atherton v. FDIC, 519 U.S. 213, 224 (1997) ("internal affairs doctrine" is described as a
"conflict of laws principle which recognizes that only one State should have the authority to regulate a
corporation's internal affairs -- matters peculiar to the relationships among or between the corporation and
its current officers, directors, and shareholders - because otherwise a corporation could be faced with
conflicting demands.") (citation omitted).
16 Anadarko Petroleum Corp. v. Panhandle E. Corp., 545 A.2d 1171, 1174 (Del. 1988) (corporations do
not owe fiduciary duties to their wholly owned subsidiaries); Lippe v. Bairnco Corp., 230 B.R. 906
(S.D.N.Y. 1999) (fmding lack of fiduciary duty of officers and directors of parent to subsidiary); AViall,
Inc. v. Ryder System, Inc., 913 F. Supp. 826 (S.D.N.Y. 1996) (fmding no duties owed to subsidiary), aff'd,
110 F.3d 892 (2d Cir. 1997); Shaev v. Wyly, No. 15559-NC, 1998 WL 13858, at *2 (Del. Ch. Jan 6, 1998)
(noting in dicta that although Andarko did not apply to the facts of the case, the holding in Andarko that a
parent did not owe fiduciary duties to a wholly owned subsidiary was a "settled rule of law"); Resolution
Trust Corp. v. Bonner, No. 92 Civ. 430, 1993 WL 414679, at * 3 (S.D. Tex. June 3, 1993) (dismissing
derivative suit against corporation because "a parent owes no duties to its wholly owned subsidiary")
(citing Anadarko).
17 Sinclair Oil Corp v. Levien, 280 A.2d 717,720 (Del. 1971); see also Getty Oil Co. v. Skelly Oil Co., 267
A.2d 883 (Del. 1970). At the Hearing, this Court cited Sinclair Oil for the proposition that a "parent may
owe a fiduciary duty to a subsidiary where there are parent-subsidiary dealings, and that parent has engaged
in self-dealing." Hearing Tr. at 18. The Sinclair Oil court explained what it meant by "self-dealing" in this
context as follows: "A parent does indeed owe a fiduciary duty to its subsidiary when there are parent~
subsidiary dealings. However, this alone will not invoke the intrinsic fairness standard. This standard will
be applied only when the fiduciary duty is accompanied by se1f-dealing--the situation when a parent is on
both sides of a transaction with its subsidiary. Self-dealing occurs when the parent, by virtue of its
domination of the subsidiary, causes the subsidiary to act in such a way that the parent receives something
from the subsidiary to the exclusion of, and detriment to, the minority stockholders of the subsidiary."
.'
Sinclair Oil, 267 A.2d at 720 (emphasis added).
-7-
relationship, including the CMS, that as a matter of law would establish a formal,
fiduciary relationship between Enron and NEPCO.
Participation in the eMS
As noted, Texas law permits a confidential relationship to be found from social or
personal relationships; or in cases in which "confidence has been reposed and
betrayed."l8 However, such confidential relationships do not arise from arms-length
business transactions. l9 Moreover, to impose an informal fiduciary duty in a business
transaction, the requisite special relationship of trust and confidence must exist "prior to,
and apart from, the agreement made the basis of the suit.,,2o Thus, participation by
NEPCO in the eMS is not sufficient to establish a special relationship of trust or
confidence under Texas law. Nothing has been discovered by the Examiner that would
suggest that there is any other basis to find a special relationship of trust or confidence
that would create an informal fiduciary relationship between Enron and NEPCO.
Use ofa Cash Management System, Without More, Not a Breach ofDuty
Even if there were a fiduciary duty or confidential relationship between Enron and
NEPCO, the decision of the Fifth Circuit Court of Appeals in Southmark Corp. v. Grosz
(In re Southmark Corpi l demonstrates that establishing a cash management system,
18 Swinehart v. Stubbeman, McRae, Sealy, Laughlin & Browder, Inc., 48 S.W.3d 865, 878-79 (Tex. Ct.
App. 2001) (citations omitted) (finding no confidential relationship in arms-length business transaction).
19 Id. Accord Conn. Res. Recovery Auth. v. Enron Corp. (In re Enron Corp.), No. 01-B-16034 (AJG),
2003 WL 1571719 (Bankr. S.D.N.Y. Mar. 27, 2003) (applying Connecticut law); LFD Operating, Inc. v.
Ames Dep't Stores, Inc. (In re Ames Dep 't Stores, Inc.), 274 B.R. 600 (Bankr. S.D.N.Y. 2002) (applying
New York law). See cases discussed at fn. 26 that find cash management systems to be an accepted and
sound business practice.
Swinehart, 48 S.W.3d at 880; In re Monnig's Dep't Stores, Inc., 929 F.2d at 201-02 (fmding 27-month
relationship between two parties to a licensing agreement not sufficient to create a confidential relationship
because Texas law requires the special relationship arise "prior to" the transaction in question).
20
21
49 F.3d 1111 (5their. 1995).
-8-
without more, does not constitute a breach of any such duty under Texas law, and
therefore, cannot justify the imposition of a constructive trust. In Southmark, the debtorparent established a cash management system to administer the financial operations and
assets of its hundreds of affiliated businesses and subsidiaries, including one known as
American Realty Advisors ("ARA,,)?2
The bank accounts established under
Southmark's cash management system commingled each company's receipts and
disbursements. The court first noted that there "is no evidence of actual fraud in the
record.,,23
Then the court held as follows: "assuming arguendo that Southmark, as
ARA's parent company and the administrator of the CMS, owed a fiduciary-like duty to
ARA, the record does not support a finding that Southmark has breached that duty.,,24
Explaining its decision, the Fifth Circuit stated that:
[a]s a parent company, Southmark was responsible for producing the
maximum .results from its investments in its subsidiaries, including ARA.
To help accomplish that goal, Southmark created the CMS . . .. But there
is no evidence . . . that Southmark violated any duty by establishing the
CMS. Neither is there evidence that Southmark misappropriated any of
ARA's deposits, used ARA's deposits in an unreasonable manner, or
abused its position with ARA by filing for bankruptcy. In short, there is
The factual background of the Southmark decision is as follows: Grosz was employed by ARA and the
relationship soured. A settlement was reached pursuant to which Grosz was paid approximately $289,000.
The check named ARA as the remitter, the W-2 Form reporting Grosz's income to the IRS identified ARA
as the payor; but the check was actually drawn on an account owned by Southmark. Southmark held
complete legal title to the account, all indicia of ownership, and unfettered discretion to pay creditors of its
own choosing. Southmark, 49 F.3d at 1116. After Southmark filed bankruptcy, it brought an action against
Grosz to recover the amounts paid as a preferential transfer. Grosz argued that the funds with which he
was paid were not property of Southmark, which is one of the elements required to establish a preferential
transfer. The lower court agreed, fmding that ARA's funds were held by Southmark in "'quasi' (or
constructive) trust," id. at 1117, and therefore, the funds were not property of Southmark's estate. The
Fifth Circuit Court of Appeals reversed.
22
23
!d. at 1118.
!d. at 1118-19. Cf, Amdura Nat'! Distrib. Co. v. Amdura Corp. (In re Amdura Corp.), 75 F.3d 1447,
1452 (10th Cir. 1996) ("The bankruptcy court found that no confidential relationship existed. The district
court concluded that a reasonable inference may be drawn that one existed, but that there was no unjust
enrichment or other abuse of the relationship to justify the imposition of a constructive trust.") (al?plying
Colorado law to a cash management system).
.
24
-9-
nothing in the record to indicate that Southmark violated any duty that it
may have owed to ARA. 25
The Examiner's investigation revealed that Enron, like other large companies,
implemented its CMS for typical business purposes. 26 Substantially all of Enron's
domestic wholly owned subsidiaries participated in the CMS. NEPCO was treated under
the CMS just like the other Enron subsidiaries that participated in the CMS. There is no
evidence of misappropriation, unreasonable use of deposits, or abuse by Enron's
bankruptcy filing. Accordingly, based on the reasoning and holding of Southmark, there
appears to be no basis to find that the eMS caused a breach of fiduciary duty to NEPCO.
c.
Unjust Enrichment
Under Texas law, the second element required to impose a constructive trust is a
showing that the party holding the property would profit by a wrong or would be unjustly
enriched if allowed to keep the property?? However, Texas courts do not reach the
25
ld. at 1119 (citing Amdura). Amdura is discussed in the next section entitled "Unjust Enrichment."
26 In other contexts, several courts have found that the use ofa cash management system is an accepted and
sound business practice. In Fletcher v. Atex, Inc., 861 F. Supp. 242 (S.D.N.Y. 1994), aff'd 68 F.3d 1451
(2d Cir. 1995), the plaintiffs attempted to pierce the corporate veil of the parent company, Eastman Kodak
Company ("Kodak") and alleged that Kodak was liable for soft tissue injuries stemming from the use of
keyboards manufactured by Kodak's subsidiary, Atex, Inc. The court rejected the plaintiffs' argument that
Atex was a mere instrumentality or alter ego of Kodak because Atex participated in Kodak's centralized
cash management system. Rather, the court stated, "Atex's participation in Kodak's cash management
system is consistent with sound business practice and does not show undue domination or controL"
Fletcher, 861 F. Supp. at 244. Other courts have held that a subsidiary's participation in a cash
management system is a sound business practice widely accepted in the corporate world and does not
justify piercing the subsidiary's corporate veiL Hillsborough Holdings Corp. v. Celotex Corp. (In re
Hillsborough Holdings Corp.), 166 B.R. 461, 471 (Bankr. M.D. Fla. 1994) (declining to pierce the
corporate veil and finding that "there is nothing inherently wrong in a parent managing all the cash
generated by the subsidiaries through a cash management system"), aff'd 176 B.R. 223 (M.D. Fla. 1994);
Tyco Laboratories, Inc. v. DASI Indus., Inc., No. 92 C 5712, 1993 WL 356929, at *10, *11 (N.D. Ill. Sept.
9, 1993) (parent corporation's use of a cash management system was not grounds to pierce the veil). Cf
United States v. Bliss, 108 F.R.D. 127, 132 (B.D. Mo. 1985) (court indicating that the use of a cash
management system was part of a usual parent-subsidiary relationship).
27 Oak CliffBank & Trust Co. v. Steenbergen, 497 S.W.2d 489 (Tex. Ct. App. 1973); Thigpen v. Lake, 363
S.W.2d 247, 250 (Tex. 1962) ("equity will impose a constructive trust to prevent one who obtains property
by fraudulent means frombeing unjustly enriched").
-10-
second element - unjust enrichment - ifthe first requirement of actual fraud or breach of a
fiduciary duty has not been shown.28 There is little useful precedent in the Texas cases
on what unjust enrichment means when seeking to impose a constructive trust, and none
applying the test to a cash management system. 29
Therefore, cases from other
jurisdictions may be instructive on the meaning of unjust enrichment in this context. For
example, in the case of Amdura Corp. v. Amdura National Distribution Co. (In re
Amdura Corp.),30 the Tenth Circuit Court of Appeals, applying Colorado law, found that
that the routine operation of a cash management system31 did not result in unjust
28 See, e.g., In re Haber, 12 F.3d 426 (not addressing unjust enrichment because of plaintiffs failure to
demonstrate first element - actual fraud or breach of fiduciary duty); In re Southmark, 49 F.3d at 1111 (5th
Cir. 1995) (not addressing unjust enrichment because no wrongful behavior demonstrated).
29 For Texas law on unjust enrichment in other contexts, see generally Formosa Plastics Corp. v. Material
P'ships, Inc., No. 01-00-00584-CV, 2002 WL 31388106, at * 6 (Tex. Ct. App. Oct. 24, 2002) ("The law
creates an implied obligation when a party is unjustly enriched in a manner not governed by binding
contract. Recovery for unjust enrichment is appropriate when an agreement is unenforceable, invalid, not
fully performed, or void for other legal reasons. Unjust enrichment applies the principles of restitution to
disputes that are not governed by contract and is usually found when a party obtains a benefit from another
by fraud, duress, or the taking of an undue advantage.") (citations omitted); Allen v. Berrey, 645 S.W. 2d
550, 553 (Tex. Ct. App. 1983) (court denied executor's unjust enrichment claim against devisees and
legatees for additional fees because executor had entered into an express contract and any recovery on an
unjust enrichment theory would be inconsistent with his recovery on the express contract: '''Unjust
enrichment' ... may be defined as the 'unjust retention of a benefit to the loss of another, or the retention
of money or property of another against the fundamental principles of justice or equity and good
conscience.").
30
75 F.3d 1447 (lOthCir. 1996).
The operation of the concentration account in Amdura appears to be consistent with the operation of
Enron's CMS. "As part of its cash management system, Amdura took the receipts of its subsidiaries each
day, concentrated them in a single account (the 'concentration account') held solely in its name and then
paid the subsidiaries' expenses from that account. In Andco's case, money from Andco's customers went
into lockbox accounts held solely in Andco's name. The banks where these accounts were located were
under standing instructions to transfer the entire contents of the lockbox account to Amdura's concentration
account each day. The other subsidiaries also used a similar arrangement to transfer their receipts to the
Amdura account. Thus, the receipts from Andco were commingled with the daily receipts from the other
subsidiaries, although Amdura kept records of how much each subsidiary deposited and how much was
spent on the operating expenses of each subsidiary. Amdura recorded all monies received in the
concentration account from a lockbox account as a debt owed by Amdura to the subsidiaries; monies
expended from the concentration account on behalf of a subsidiary were recorded as a debt owed by the
subsidiary to Amdura. On any given business day, the balance owed by Amdura to a subsidiary (and vice
versa) would therefore increase or decrease depending npon whether the amounts transferred from the
31
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enrichment of the parent.32 The Tenth Circuit stated that:
"[t]here is nothing in the record to support [the subsidiary's] suggestion
that the transfer of lockbox funds into the concentration account, at all
other times a routine procedure, became on the eve of bankruptcy an
attempt to plunder [the subsidiary's] corporate assets. Nor is there
evidence of other misbehavior on Amdura's part.... Colorado does not
require actual fraud in order to impose a constructive trust. ... However,
some kind of abuse or unjust enrichment must be shown and it is up to the
plaintiff to show it. [The subsidiary] cannot meet that burden merely by
imputing evil intent to a business arrangement in which it willingly
participated and to which it didn't object prior to filing for bankruptcy.33
Another case, LFD Operating, Inc. v. Ames Department Stores, Inc. (In re Ames
Department Stores, Inc}4 applied New York's principles-of unjust enrichment in an
analogous situation. LDF Operating involved the "store-within-a-store" pattern common
to the operation of many retail department stores. 35 LFD sold footwear in Ames' stores
and the sales proceeds were collected by Ames and deposited into Ames' accounts.
Ames was to pay the proceeds of those sales (less certain deductions) to LFD each week,
in arrears. During the week prior to bankruptcy, Ames decided to preserve cash, and
except for payroll, few payments were made. 36 As of the bankruptcy, LFD was owed
$8.9 million. LFD contended that it was entitled to the imposition of a constructive
subsidiary to the concentration account were greater or less than the amounts Amdura advanced on behalf
of that subsidiary. This arrangement gave Amdura complete control over the funds in the concentration
account. Amdura paid its subsidiaries' obligations without regard to how much cash a particular subsidiary
had deposited into the account. Additionally, Arndura used the account for its own deposits and
withdrawals, and all interest accrued on the account went to Amdura." Amdura, 75 F.3d at 1449.
"The bankruptcy court found that no confidential relationship existed. The district court concluded that
a reasonable inference may be drawn that one existed, but that there was no unjust emichment or other
abuse of the relationship to justify the imposition of a constructive trust." ld. at 1452.
32
33
!d. (citations omitted).
34
274 B.R. 600 (Bankr. S.D.N.Y. 2002).
35
274 B.R. at 605.
36
ld. at 612.
-12-
trust,37 asserting that Ames was its fiduciary, and alternatively, because Ames
"converted" the $8.9 million. The court found that no fiduciary duty existed and that no
conversion occurred. The court then stated:
In addition ... the Court finds that Ames has not been unjustly enriched.
Unjust enrichment results when a person retains a benefit which, under the
circumstances of the transfer and considering the relationship of the
parties, it would be inequitable to retain that benefit. "The existence of
unjust enrichment is essentially a legal inference drawn from the
circumstances surrounding the transfer of property and the relationship of
the parties. The relationship between Ames and LFD is arms-length and
contractual in nature. Both LFD and Ames are sophisticated corporate
entities with millions of dollars in revenues. Ames has operated under the
Agreement in a consistent manner since 1987. . . ~ [T]he commercial
relationship between Ames and LFD is indistinguishable from . . . that of
debtor-creditor. Under the circumstances of this case and considering the
sophistication of both Ames and LFD, the Court finds that it would be
equitable for Ames to retain the benefits ofthe [$8.9 million].38
The CMS appears to have been on ordinary business terms and was contractual in
nature.
Both Enron and NEPCO were sophisticated corporate entities with large
revenues. The CMS operated in a consistent manner at all relevant times. Prior to being
acquired by Enron, NEPCO was part of the cash management system of its former parent.
The relationship between Enron and NEPCO under the CMS was that of debtor-creditor,
like all other Enron subsidiaries that were participants in the CMS. Accordingly, the
Examiner concludes that the participation byNEPCO in the CMS, even though it may
have resulted in a net balance in Enron's favor as of the date of Enron's petition, would
not be considered to be "unjust enrichment" of Enron.
37 LFD's constructive trust argument was only one of many arguments made by LFD to support its claim
that the $8.9 million was LFD's property. The court rejected each ofLFD's arguments.
38
274 B.R. at 630-31 (citations omitted) (emphasis added).
-13-
D.
Tracing the Res
The third element necessary for the imposition of a constructive trust requires the
claimant to point to some identifiable property in possession of the putative trustee over
which it can assert .a trust. 39 It is insufficient to show that trust property went into the
general estate and increased its value. 40 If trust property cannot be traced, the beneficiary
of the trust holds only a claim as a general creditor.against the debtor's estate.41
Courts recognize the difficulty in tracing intangible assets such as funds deposited
III
bank accounts, especially when trust funds and non-trust funds are commingled.
Commingling funds with other funds in an account does not by itself preclude tracing. 42
In such a case, courts apply the "lowest intermediate balance" rule to trace the trust
funds. 43 The lowest intermediate balance rule presumes that the trust funds are the last
39 Salisbury Inv. Co. v. Irving Trust Co. (In re United Cigar Stores Co.), 70 F.2d 313, 316 (2d Cir. 1934);
Majutama v. Drexel Burnham Lambert Group Inc. (In re Drexel Burnham Lambert Group, Inc.), 142 B.R.
633,637 (Bankr. S.D.N.Y. 1992).
40
Salisbury Inv. Co., 70F.2d at 316.
Sonnenschein v. Reliance Ins. Co., 353 F.2d 935 (2d Cir. 1965); Cassirer v. Herskowitz (In re Schick),
234 B.R. 337, 342 (Bankr. S.D.N.Y. 1999).
41
Majutama, 142 B.R. at 638 (commingled funds can be traced); see also George Gleason Bogert &
George Taylor Bogert, The Law of Trusts and Trustees § 921 (rev. 2d ed. 1995) ("[I]fthe trust property can
be traced step by step in the dealings of the trustee and others, it does not matter how many changes in form
have been experienced or what the nature of the substitute property nOw is.").
42
43 Salisbury Inv. Co., 70 F.2d at 316 ("If a trustee mingles the trust funds with the mass of his other funds,
as long as there remains on hand a sufficient sum to cover the amount of the trust fund, the cestui que trust
may follow the trust fund and reclaim it."); Majutama, 142 B.R. at 638; Official Comm. of Unsecured
Creditors of Columbia Gas Transmission Corp. v. Columbia Gas Systems Inc. (In re Columbia Gas
Systems, Inc.), 997 F.2d 1039, 1053, 1063~64 (3d Cir. 1993) ("When a trustee commingles trust funds with
other monies in a single account, the lowest intermediate balance rule aids beneficiaries in tracing trust
property. The lowest intermediate balance rule ... allows trust beneficiaries to assume that trust funds are
withdrawn last from a commingled account. Once trust money is removed, however, it is not replenished
by subsequent deposits. Therefore, the lowest intermediate balance in a commingled account represents
trust funds that have never been dissipated and which are reasonably identifiable.... [A] trust beneficiary
also loses property rights in a commingled account to the extent that account drops below the amount held
in trust. This is the eSSence of the lowest intermediate balance test.").
In Sonnenschein v. Reliance Insurance Co., 353 F.2d 935, 937 at frI. 2 (2d Cir. 1965), the Second
Circuit recognized that it was unsettled "whether state or federal law governs the extent to which a trust
beneficiary must identify trust property," but stated that "in this case the problem is academic sin(';e both
-14-
funds to be used from a cornrningledaccount. Thus, the trust is preserved, even as funds
are removed from the account, unless the balance of the account drops below the value of
the trust. Once the account balance drops below the amount of the asserted trust, the
value of the trust is lowered to the lowest amount in the account - the lowest intermediate
balance. 44 Therefore, if the account balance is reduced to zero, the res is exhausted, and
there is no property to which a constructive trust can attach. 45 Any funds added to the
account by the trustee do not restore the trust funds. 46
state and federal law require specific identification of trust funds.... " It does not appear that the Second
Circuit has ever ruled on this issue. Like the court did in Sonnenschein, courts in the Second Circuit apply
the lowest intermediate balance test when tracing funds. See, e.g., Majutama, 142 B.R. at 638; American
Hull Ins. Syndicate v. United States Lines, Inc. (In re United States Lines, Inc.), 79 B.R. 542 (S.D.N.Y.
1987); Savoy Records, Inc. v. Trafalgar Assocs. (In re Trafalgar Assocs.), 53 B.R. 693 (S.D.N.Y. 1985).
Some Circuits have held that federal law determines the method for tracing assets because tracing pertains
to the disposition of assets from a bankrupt entity. See, e.g., Goldberg v. New Jersey Lawyers' Fund for
Client Protection, 932 F.2d 273,280 (3d Cir. 1991) (looking to state law to determine whether the claimant
demonstrated a trust relationship and to federal law for tracing and identifying funds because tracing
pertains to distribution of assets frOlll an entity in federal bankruptcy); Conn. Gen'l. Life Ins. v. Universal
Ins., 838 F.2d 612,619 (1st Cir. 1988) (same; "normal rule for construing trust proceeds commingled in a
bank account is known as the 'lowest intermediate balance test; '" court does not apply any other rule);
Wisconsin v. Reese (In re Kennedy & Cohen, Inc.), 612 F.2d 963 (5th Cir. 1980); City ofFarrel v. Sharon
Steel Corp., 41 F.3d 92, 95 (3d Cir. 1994). At least one court has used a tracing method qther than the
lowest intermediate balance rule in the context of commingled funds. In EBS Pension, LLC v. Edison
Brothers Stores, Inc. (In re Edison Brothers, Inc.), 243 B.R. 231 (Bankr. D. Del. 2000), the court held that
federal common law, not state law, should be used to determine whether or not to impose a constructive
trust, and held that the "nexus" method used in Begier v. IRS, 496 U.S. 53 (1990), for federal trust fund
taxes could be applied to commingled funds. In a later decision in the same proceeding, EBS Pension, LLC
v. Edison Brothers Stores, Inc. (In re Edison Brothers, Inc.), 268 B.R. 409 (Bankr. D. Del. 2001), the court
found that the result in that case was the same under the lowest intermediate balance test and the nexus
test-no trust property had been sufficiently identified.
Majutama, 142 B.R. at 637 (citing 4 Lawrence P. King, Collier on Bankruptcy
1992».
44
11
541.13 (15th ed.
Sonnenschein v. Reliance Ins. Co., 353 F.2d 935 (2d. Cir. 1965); Majutama, 142 B.R. at 638 (under the
lowest intermediate balance rule, "[t]he law is clear . . . if the funds in the commingled account are
completely dissipated, there is no res to discover.").
45
46 Schuyler v. Littlefield, 232 U.S. 707 (1914); US. v. Coriaty, 300 F.3d 244, 253 (2d Cir. 2002)
(addressing the lowest intermediate balance rule in the context of restitution from loss due to fraud);
Official Comm. ofUnsecured Creditors ofColumbia Gas Transmission Corp. v. Columbia Gas Sys. Inc. (In
re Columbia Gas Sys., Inc.), 997 F.2d 1039, 1053, 1063-64 (3d Cir. 1993) (applying lowest intermediate
balance test to a cash management account and held that the debtor could only distribute the funds that
were in the account at the time of the bankruptcy filing even though more funds were later added);
Majutama., 142 B.R. at 638; EBS Pension L.L.c. v. Edison Bros. Stores, Inc. (In re Edison Bros., Inc.), 268
B.R. 409 (Bankr. D. Del. 2001).
-'
-15-
Intricate cash management systems present additional tracing Issues.
For
example, the balances in some of the CMS accounts were reduced to zero each night for
the purpose of an overnight loan which was repaid the next morning, with interest, to the
same account. At least one case, American Hull Insurance Syndicate v. United States
Lines, Inc. (In re United States Lines, Inc.},47 has held that such overnight investments "in
no way" dissipate the account for purposes of the lowest intermediate balance rule.
The sheer number of accounts that make up the structure of cash management
systems raises another issue. Courts recognize that tracing of funds can occur from one
account toanother,48 but courts do not permit a group of accounts to be treated as one
"general" account. 49
In some cases, it is claimed that even though a commingled trust account balance dropped below
the value of the res, later deposited funds "replenished" the trust corpus. This doctrine, however, applies
only to express trusts and/or accounts expressly identified as trust accounts. Goldberg v. New Jersey
Lawyers' Fundfor Client Protection, 932 F.2d 273,280 (3d Cir. 1991). In this situation, the intent of the
wrongdoer to replenish the account may be an issue. Stevenson v. J.c. Bradford (In re Cannon), 277 F.3d
838 (6th Cir. 2002). For example, in Stevenson, the court examined an escrow account containing only
trust funds from which the trustee of the account misappropriated funds, and subsequently made later
deposits into the trust with his own funds. "Under general common law principles, these funds became part
of the escrow account and are added to the sums held in express trust on behalf of[debtor's] clients." !d. at
851. This is because it is accepted that later deposits of a trustee's own money into a misappropriated trust
account are presumed to be restitution for the stolen funds when the account is expressly labeled a trust
accOunt. Id. However, direct evidence of intent may be required in the context of commingling a
wrongdoer's personal bank account with alleged trust funds. In re Gottfried Baking Co., 312 F. Supp. 643,
645 (S.D.N.Y. 1970). The doctrine of replenishment does not apply here. There is no evidence that either
NEPCO or Enron considered the deposits to be trust deposits and, consequently, no evidence that Enron's
daily additions to the Citibank concentration account (from borrowings or cash receipts of other affIliates)
were intended by it to "replenish" a trust.
47
79 B.R. 542 (Bankr. S.D.N.Y. 1987).
American Hull Ins. Syndicate v. United States Lines, Inc. (In re United States Lines, Inc., 79 B.R. 542
(Bankr. S.D.N.Y. 1987).
48
Conn. Gen'l Life Ins. Co., 838 F.2d at 619-20 ("Here, there is no dispute that the lowest intermediate
balance in the account into which the insurance proceeds were deposited is zero. CG attempts to overcome
the obvious conclusion that it is thus entitled to take nothing by arguing, in essence, that the hotel
corporation had not twelve separate bank accounts, but one general 'cash-in-banks' account. CG bases this
fictional combined bank account on the hotel's fmandal statements, which list 'cash' as a single item. The
fact that multiple accounts are consolidated for accounting purposes on a single line of the fmandal
statement does not, of course, mean that they are effectively one account. Nor does it obviate the need for
tracing the assets in any particular account. The point of tracing is to follow the particular entrusted assets,
not simply to identify some assets. The Second Circuit faced a similar situation in In re United Cigar
49
-16~
Just how far tracing can be permitted into a web of accounts was an issue in
Majutama v. Drexel Burnham Lambert Group, Inc. (In re Drexel Burnham Lambert
Group, Inc.).5o Perhaps significantly, Majutama did not involve a cash management
system; rather, the debtor simply had many accounts. The balance of the first bank
account into which the plaintiffs funds were deposited had dropped below zero before
the debtor filed for bankruptcy. The bankruptcy court permitted the plaintiff to attempt to
trace the funds not only in the first account, but also "permitted discovery of all of [the
debtor's] other accounts, and even of the outflow from [those] accounts.,,51 The plaintiff
was still unable to trace the funds. On appeal, the district court stated that, pursuant to
the lowest intermediate balance rule, the inquiry for tracing the funds should have ended
when the balance in the first account reached zero. 52 The court disagreed with the
plaintiffs attempt to trace the funds into all of the assets of the bankruptcy estate, into
"whomever's hands, in whatever form" they might be found. 53 Because the funds at
issue had been dissipated pre-bankruptcy to satisfy debts of the debtor and were not
converted into another asset, there was no res for the plaintiff to trace or over which to
assert a constructive trust. 54
Stores Co., 70 F.2d 313 (2d Cir. 1934). There, the claimant was a joint venturer of the bankrupt and
asserted a trust interest in several of the bankrupt's bank accounts. The court rejected the claim, both on
the grounds that a trust relationship was not proven, and because the trust funds were not traced. On the
issue of tracing, the court noted that, while the aggregate balance of the bank accounts had been shown to
be above the alleged trust amount at all times, the claimant had failed to trace the specific assets of any
particular account, which might well have been depleted at some point. As in United Cigar Stores, CG has
not directed this court to any particular asset of the hotel corporation where the alleged trust fund remains,
even partially, intact.")
50
142 B.R. 633 (Bankr. S.D.N.Y. 1992).
51
ld.
52
ld. at 638.
53
!d.
54
ld. at 638-40.
-17-
Courts have allowed the tracing of putative trust property into specific property
acquired with such funds even if all of the funds from a commingled account are
withdrawn. 55 The ability to trace a res into other property generally occurs when a
specific property is sold and the proceeds of that sale are used to purchase other specific
property. 56 The Examiner has found no case in which funds commingled in a cash
management account were permitted to be traced into other general assets. Indeed, courts
have consistently disallowed a creditor's attempt to trace its putative trust into the general
assets ofthe debtor. 57
55 In re Anjopa Paper & Board Mfg. Co., 269 F. Supp 241 (S.D.N.Y. 1967) (fmding claimant entitled to an
equitable lien on the dissipated funds and is entitled to follow his tnoney into the property acquired with
such funds); 5 Austin Wakeman Scott & William Franklin Fratcher, The Laws of Trusts § 516 (4th ed.
1989).
56 Majutama, 142 B.R. at 639 (Bankr. S.D.N.Y. 1992) (hypothesizing that if the debtor had taken the
claimant's deposit in its bank account and used the funds to purchase a cow, the claimant could trace the
trust res to the cow in the debtor's hands).
Id. at 637; Salisbury lnv. Co. v. Irving Trust Co. (In re United Cigar Stores Co.), 70 F.2d 313 (2d Cir.
-'
1934).
57
-18-
IV.
BANKRUPTCY LAW IMPACT ON CONSTRUCTIVE TRUSTS
As has been discussed above, bankruptcy courts generally look to state law to
determine if a constructive trust should be imposed. In the Second Circuit, when a
constructive trust is found, the property to which the constructive trust attaches is not
considered property of the estate, and the trust property should be returned to the
claimant. 58 Accordingly, constructive trusts are recognized as a potent weapon and the
temptation for a claimant to seek to convert its claim into a .constructive trust is great. 59
The Examiner has concluded that, under Texas law, NEPCO cannot establish a
constructive trust in its favor. Were NEPCO able to demonstrate the requisite elements
necessary to establish a constructive trust, the Examiner believes it is appropriate, in the
interest of thoroughness, to identify a few notable decisions that refuse to recognize
constructive trusts in bankruptcy cases. None of these decisions are from the Second
Circuit Court of Appeals.
In the case of XL/Datacom, Inc. v. Wilson (In re Omegas Group, Inc.),6o the Sixth
Circuit Court of Appeals held that Section 541(d) of the Bankruptcy Code simply does
not permit a claimant the remedy of a constructive trust. According to the court, a
constructive trust, unlike an express trust, is only a remedy until a plaintiff obtains a
judicial decision entitling it to a judgment impressing the defendant's property or assets
58 Koreag, 961 F.2d at 352; Howard's Appliance Corp., 874 F.2d at 93; Conn. Res. Recovery Auth. v.
Enron Corp. (In re Enron Corp.), No. 01-B-16034 (AJG), 2003 WL 1571719 (Bankr. S.D.N.Y. Mar. 27,
2003).
59 Haber Oil Co. v. Swinehart (In re Haber Oil Co.), 12 F.3d 426,436 (5th Cir. 1994) (noting a reluctance
of courts to impose constructive trusts because they can "wreak such havoc with the priority system" under
the Bankruptcy Code); see also PlasmaNet, Inc. v. Phase2Media Inc. (In re Phase2Media Inc.), No. 0114020 (ALG), 2002 Bankr. tEXIS 1457, at *33 (Bankr. S.D.N.Y. Dec. 20, 2002) ("In a bankruptcy case,
in considering whether equity demands the creation of a COllStructive trust to prevent unjust enriclunent, it
is necessary to take into account that the contest is not between the transferee of funds and alleged
beneficiary of the constructive trust, but between the debtor's other creditors and the putative beneficiary.")
60
16 F.3d 1443 (6th Cir. 1994).
)
-19-
with such a truSt. 61
Therefore, a constructive trust is not a property interest. 62
Accordingly, the court found that a constructive trust is simply a claim in the bankruptcy
case (absent ajudicial determination recognizing the trust prior to the petition date).63
In addition, some courts have recognized that constructive trust claims, because
they can be satisfied by money damages, are claims which, under Section 101(5)64 of the
Bankruptcy Code, are entitled only to general priority.65 For example, in In re CRS
Steam,66 the court reasoned that the Bankruptcy Code's definition of "claim" conflicts
with state law that recognizes a constructive trust as a property interest.
The court
therefore found that constructive trusts, as equitable remedies, are unambiguously
captured within the meaning of "claim.,,67 If a constructive trust is nothing more than an
equitable remedy, the court reasoned, then it falls within the definition of "claim" and, if
it can be reduced to a monetary judgment, is only entitled to allowance as a general
61 16 F.3d at 1451 (The Sixth Circuit recognized the application of Kentucky state law to the question, but
further stated that state law must be applied in a manner consistent with federal bankruptcy law and federal
policy.)
62
Id. at 1449.
63
Id. at 1452.
64
11 U.S.C. § 101(5)(B).
See Tecldnsight.Com, Inc. v. Stylesite Mktg., Inc. (In re Stylesite Mktg., Inc.), 253 B.R. 503,511 (Bam.
S.D.N.Y. 2000); CRS Steam, Inc. v. Eng'g. Res., Inc. (In re CRS Steam, Inc.), 225 B.R. 833, 841 (Bankr. D.
Mass. 1998); In re Ames, 274 B.R. at 630 (referring to CRS Steam as the leading case as to whether
equitable remedies are claims under Section 101(5)); cf In re Omegas Group, Inc., 16 F.3d 1443, 1449 (6th
Cir.1994).
65
66
In re CRS Steam, 225 B.R. at 844-45 (constructive trust is a fiction creating no property interest).
67
Id. at 844.
-20-
claim. 68
Such a "result squares with the central bankruptcy policy of equality of
distribution" and "also reflects the reality ofbankruptcy.,,69
68
Id. at 845.
!d. at 842. The Bankruptcy Court in In re Nova Tool & Engineering, Inc., 228 B.R. 678 (Bankr. N.D.
Ind. 1998) and Berger Shapiro & Davis v. Haeling (In re Foos), 183 B. R. 149 (Bankr. N.D. Ill. 1995),
both found that the use of the term "constructive trust" was misleading in that a constructive trust and a true
trust are entirely different concepts. In both cases, the courts cited Omegas Group with favor and declined
to impose a constructive trust, especially where the trust had not been imposed under applicable state law
prior to the petition date.
.'
69
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